Lagarde says ‘impossible’ for ECB to always guarantee 2% inflation

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European Central Bank president Christine Lagarde said the ECB was becoming less able to guarantee meeting its 2 per cent inflation target in the short term, as policymakers were forced to wrestle with “exceptionally high” uncertainty.

A week after the central bank signalled a possible slowdown in cuts to borrowing costs, after reducing its benchmark interest rate for the sixth time, Lagarde told a conference in Frankfurt that the environment had become so difficult that it would be “impossible” to guarantee that “headline inflation will always be at 2 per cent”.

The comments will fuel doubts over the pace and frequency of potential future rate cuts, and come after Lagarde last week withdrew her previous guidance that “the direction of travel” — further gradual cuts — was “clear” for the ECB.

That change in tone from the ECB president reduced expectations of another rate cut in April, with several banks now expecting that rates will be cut less by the end of the year than previously forecast.

The ECB’s 2 per cent target — introduced in 2021 — covers “the medium term” and allows for short-term deviations in real time inflation trends.

Lagarde stressed that the ECB’s goal was to ensure that “inflation is always converging back towards 2 per cent over the medium term”, adding that the bank would stay clear of committing to any particular rate path.

“Our medium-term orientation enables us to avoid reacting to small or passing shocks that will have faded by the time the effects of a policy change kick in,” she said, adding that the ECB could “adjust the horizon within which we must return inflation to target”.

The ECB president said higher public borrowing to fund defence and infrastructure investment, as well as a potential trade war involving the US, “might feed into inflation more directly and increase volatility”.

The euro area might be particularly vulnerable “as we are highly exposed to some of the new types of shock” because of its large dependence on global trade and energy imports, she warned. Larger shocks might come with the risk that inflation could be more sticky, she added.

Escalating tariffs, as well as a big debt-funded push to increase defence and infrastructure spending by Germany and other euro countries, could create “new, two-sided shocks” that could either damp or accelerate inflation, the ECB president said.

“The direction of shocks is much harder to predict,” she said.