In a speech at the “ECB and Its Watchers” conference, European Central Bank President Christine Lagarde discussed how the ECB’s monetary policy framework and communication should adapt to a more volatile geopolitical environment, while keeping a strong medium-term commitment to its symmetric 2% inflation target. She argued that uncertainty and more complex shocks increase the need for policy agility, but that agility must be anchored by clarity about the ECB’s reaction function so that expectations remain well guided. Lagarde highlighted three changes shaping the inflation environment: less predictable, two-sided shocks; potentially larger and more direct pass-through to inflation, particularly for the open and energy-import-dependent euro area; and the possibility of greater inflation persistence, including via more frequent price changes and staggered wage adjustment. She stressed that “looking through” shocks remains conditional on inflation expectations staying well anchored, citing ECB analysis suggesting that if expectations had been as poorly anchored as in the 1970s, policy rates might have needed to rise to 8% at the peak of the recent tightening cycle. On communication, she cautioned that detailed rate-path forward guidance can constrain policy when the size and distribution of shocks are highly uncertain, pointing to the limitations of projection-based lift-off criteria during the 2021–22 inflation surge. Instead, she emphasised “framework guidance” based on scenario and sensitivity analysis (including scenarios related to tariffs and fiscal policy changes) and the ECB’s three decision inputs set out in March 2023: the inflation outlook including risks, underlying inflation dynamics and the strength of transmission. She also underlined the role of ECB liquidity provision and its backstop instruments, including Outright Monetary Transactions and the Transmission Protection Instrument, in supporting confidence during market stress. The remarks were framed as input to the ECB’s ongoing strategy assessment, with an expectation that the reaction function and the data set supporting decisions should explicitly incorporate risk and uncertainty and may evolve depending on the shocks faced.
European Central Bank 2025-03-12
European Central Bank sets out case for agile monetary policy and clearer reaction-function guidance amid rising geopolitical uncertainty
ECB President Christine Lagarde, at the "ECB and Its Watchers" conference, emphasized adapting the monetary policy framework to geopolitical volatility while maintaining a 2% inflation target. She highlighted policy agility anchored by clear communication amid unpredictable shocks and potential inflation persistence. Lagarde stressed the limitations of detailed rate-path guidance, advocating for "framework guidance" based on scenario analysis and ECB decision inputs.