ECB President discusses policy responses to energy shocks and economic uncertainty

Christine Lagarde, President of the European Central Bank (ECB), delivered a keynote speech at the “The ECB and Its Watchers” conference organized by the Institute for Monetary and Financial Stability at Goethe University Frankfurt.

She highlighted that recent economic conditions have changed significantly from earlier expectations, with increased uncertainty about the economic outlook due to geopolitical and energy market shocks.

Lagarde explained that the ECB’s monetary policy strategy is guided by three principles:

• Assessing the nature, size, and persistence of shocks before policy decisions.
• Focusing on risks and working with scenarios, not only the baseline outlook.
• Applying a graduated set of responses depending on the shock’s intensity and duration.

She discussed the historical context of energy shocks and their potential to influence inflation, noting that in the euro area, small, short-lived shocks typically stay contained within energy prices. However, larger or persistent shocks could have broader inflationary effects, especially if macroeconomic conditions favor pass-through.

Lagarde pointed out that current conditions differ from 2022, with smaller shocks so far, a more moderate economic environment, and less supportive macroeconomic policies. Nonetheless, she emphasized vigilance due to ongoing supply disruptions and geopolitical tensions.

The ECB has developed scenario analyses to prepare for different outcomes, including an adverse scenario with a short but intensified shock and a severe scenario with a prolonged and broader impact. These scenarios underscore the non-linear risks to inflation and the importance of early detection of broadening effects.

She stressed the importance of monitoring indicators such as commodity prices, firms’ price expectations, wage trends, and consumer confidence to inform policy adjustments. The ECB remains committed to a data-dependent, flexible approach, ready to act as needed while maintaining its medium-term inflation target of 2%.

In conclusion, Lagarde emphasized that the ECB’s strategy is designed for a world of higher uncertainty, with a focus on risk assessment and scenario planning. The ECB will act decisively when necessary but will avoid hesitation until sufficient information is available.