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Keeping inflation in check will become harder as trade tensions and other “structural shifts” make the world more volatile, the European Central Bank has warned, as it vowed it would fight high price growth with “forceful or persistent” actions.
European rate-setters have tweaked their strategy to emphasise the risk of sudden but persistent increases in inflation, after they were caught out by a jump in price rises in 2021-22 partly due to the war in Ukraine. The previous strategy focused on the then-relevant risk of deflation.
“Structural shifts such as geopolitical and economic fragmentation and increasing use of artificial intelligence make the inflation environment more uncertain,” the ECB warned in a monetary policy strategy statement on Monday.
“Supply shocks are becoming more frequent,” Lagarde said in a speech on Monday night at the start of the ECB’s annual international conference in Sintra, Portugal.
The ECB is keeping the medium-term 2 per cent inflation target that was introduced four years ago, stressing that it will fight “large, sustained deviations of inflation from target in either direction”.
It vowed to apply a “forceful or persistent” response to do so, adding that it was bracing to fight “larger target deviations in both directions” in future.
ECB president Christine Lagarde told reporters on Monday that while the new environment gave citizens “many reasons to worry . . . one thing that they do not need to worry about is our commitment to price stability”.
The central bank has drastically changed its monetary policy since 2022. It first rushed to end its bond-buying programme and then raised interest rates from minus 0.5 per cent to a record high of 4 per cent within 14 months.
Otherwise, inflation expectations would have got out of control in 2022 and 2023 with a probability of more than 30 per cent, Lagarde said in Sintra, pointing to ECB research.
It then halved borrowing costs to 2 per cent since June last year as inflation moderated. Investors are betting on one more quarter-point rate cut by the end of the year, according to Reuters data.
Inflation has slowed from a peak of almost 11 per cent in late 2022 and fell below its medium-term 2 per cent target last month.
Interest rates would remain as the preferred policy method, but the ECB would keep the controversial bond-buying tools it introduced during the years of ultra-low inflation and negative interest rates and which dramatically inflated its balance sheet, it said.
The document is the first review of its policy since 2021, with Lagarde saying the next review was planned for 2030.
The central bank said it would keep the options to buy assets and to provide cheap, longer-running funding to banks — either to safeguard “the smooth functioning of monetary policy transmission” or when interest rates “are close to the lower bound”.
“Our strategy assessment has been an exercise in evolution, not revolution,” Lagarde said, adding that “many of its conclusions are already reflected in our current policy conduct”.
Société Générale economist Anatoli Annenkov wrote in a note to clients that while the new ECB strategy was “commendably transparent”, it “cannot prevent mistakes in identifying temporary or sustained deviations from target”.
