European Central Bank President Christine Lagarde has indicated that the resilience of the eurozone economy and the central bank's policy toolkit have significantly strengthened. This means that even if faced with new inflationary shocks in the future, the ECB would not need to repeat the aggressive interest rate hiking cycle seen from 2022 to 2023. Instead, it would adjust rates more flexibly based on the nature of the shock.
Speaking at the opening of the ECB's annual Sintra Forum on Monday, Lagarde stated that the euro area may face various shocks that push inflation away from its target more frequently. However, most of these situations would fall into a "grey area" between shocks that can be ignored and those that require a forceful response. She believes that Europe has built greater economic resilience, making the impact of such shocks more manageable. The ECB will also rely on new tools and decision-making frameworks developed in recent years to continuously enhance its policy response capabilities.
She noted that this resilience stems from the ECB's expanding policy toolkit, the strengthening of the eurozone's financial architecture, and a series of institutional developments, including joint banking supervision. Lagarde pointed out that the euro area has "weathered the largest U.S. tariff increase in nearly a century and the largest oil supply disruption in history, as termed by the International Energy Agency." While the cost was not insignificant, the European economy "has not been thrown off course."
Lagarde stated that interest rates have once again become the ECB's primary policy tool, moving beyond the policy framework used for over a decade following the financial crisis. Future monetary policy will continue to be data-driven and decided on a meeting-by-meeting basis, rather than relying on complex forward guidance.
She added that in recent years, the ECB has utilized data analysis techniques to monitor economic and price changes in real-time and has significantly improved its forecasting capabilities. After failing to accurately predict the surge in inflation from 2022 to early 2023, the ECB switched to more refined forecasting models for oil, natural gas, and electricity prices. Since the outbreak of the Middle East conflict, forecasting errors have remained very small. By continuously cross-verifying forecasts with the latest data, the ECB can promptly confirm whether its assessments remain valid.
Lagarde believes this framework also buys more time for policymakers. As financial markets typically price in policy adjustments before they are officially implemented, the ECB does not need to act hastily and can make decisions after fully analyzing the data. She noted that markets had fully anticipated the June rate hike before it was officially enacted, giving policymakers more time to verify data and assess the situation.
Regarding recent policy decisions, Lagarde emphasized that the ECB's 25-basis-point rate hike two weeks ago was not a "precautionary hike" to guard against future risks, but a reasonable decision under all assessed scenarios. She stated that without that hike, eurozone inflation would have remained above the 2% target in 2027 and 2028. According to the ECB staff's baseline projections published in June, inflation is expected to return to 2% in 2027.
In May, eurozone inflation rose to 3.2%. The ECB subsequently raised borrowing costs by 25 basis points to 2.25% in June, making it the first G7 central bank to increase borrowing costs following the outbreak of the US-Israel-Iran conflict.
Lagarde noted that while international oil prices have retreated following the extension of the US-Iran ceasefire, this has not altered the ECB's previous policy assessment. "In all the scenarios we considered, the decision to raise rates was justified," she said. "Nothing we have observed since then has called that judgement into question."
She also pointed out that, compared to 2022-2023, the ECB is "no longer required to act with the same forcefulness." During that period, to combat high inflation, the ECB initiated its fastest-ever rate-hiking cycle, raising the benchmark deposit rate from -0.5% to 4% in just over a year.
Regarding the future path of interest rates, Lagarde did not provide new forward guidance. According to calculations, markets still expect the ECB to implement another 25-basis-point rate hike before October.
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