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ECB's Lagarde says "Small, one-off and short-lived supply shocks can be looked through. But as expected deviations from our inflation target grow larger and more persistent, the case for action becomes stronger."

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ECB's Lagarde says "Small, one-off and short-lived supply shocks can be looked through. But as expected deviations from our inflation target grow larger and more persistent, the case for action becomes stronger."

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  • "When the energy shock hit in 2021–22, several of these channels were operating simultaneously. But there are factors today which point to a lesser pass through."; namely, the initial shock has thus far been smaller, and today's macroeconomic backdrop is more benign.
  • "We will not act before we have sufficient information on the size and persistence of the shock and its propagation. But we will not be paralysed by hesitation: our commitment to delivering 2% inflation over the medium term is unconditional."

Three broad cases

  • "First, if the energy shock is seen to be limited in size and short-lived, the classical prescription of looking through should apply"
  • "Second, if the shock gives rise to a large though not-too-persistent overshoot of our target, some measured adjustment of policy could be warranted."
  • "Third, if we expect inflation to deviate significantly and persistently from target, the response must be appropriately forceful or persistent. "
  • Lagarde notes, "It is too early to say where on this spectrum we will need to be. Fortunately, we can assess the situation carefully, because we are entering this shock from a good starting point. The policy stance is broadly neutral, inflation has been on target for around a year and longer-term inflation expectations are well-anchored."

Context

Lagarde's comments indicate a nuanced approach to potential supply shocks, suggesting the ECB will carefully assess their impact on inflation before taking action. Her emphasis on not overreacting to temporary disturbances while affirming a commitment to the 2% inflation target highlights a balance between caution and responsiveness in monetary policy. This could imply that markets may not expect immediate rate changes unless inflation deviations are deemed significant and persistent, which could keep EUR and fixed income stable in the near term.

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