By Paul Hannon
The European Central Bank would have to respond forcefully if inflation threatened to rise significantly above its target for a long time as a consequence of the conflict in the Middle East, President Christine Lagarde said Wednesday.
However, the policymaker said the key rate wouldn't be lifted until there is "sufficient" information available to judge the likely impact of the conflict.
"If we expect inflation to deviate significantly and persistently from target, the response must be appropriately forceful or persistent," she said in a speech.
The ECB last week left its key interest rate unchanged, while its economists provided forecasts for a number of scenarios linked to developments in the Middle East.
In their "severe" scenario, damage to energy facilities would lead to oil and natural-gas prices remaining high beyond the end of this year, with inflation peaking at an average of 4.8% in 2027.
In an "adverse" scenario, inflation would instead peak at 3.5% this year, but fall close to target in 2027. Lagarde said such an outcome would warrant a smaller response to assure Europeans that inflation would be contained.
"To leave such an overshoot entirely unaddressed could pose a communication risk: the public may find it difficult to understand a reaction function that does not react," she said.
Europe's top central banker said it is also possible that if the energy shock is limited and of short duration, the key rate could be left unchanged.
"It is too early to say where on this spectrum we will need to be," she said.
European policymakers have been chastened by a sharp rise in energy and food prices after Russia's full-scale invasion of Ukraine in 2022. That led to a jump in wage demands and higher prices for a range of labor-intensive services. As a result, inflation stayed above their target for longer than they had expected.
They worry that memories of that experience mean workers will be quick to demand higher wages this time around, triggering another round of price rises.
"If the shock does intensify, the response of firms and workers may be faster than last time," Lagarde said. "We have a more recent memory of high inflation, which could affect how quickly costs are passed on and compensation is sought."
However, Lagarde highlighted the differences between the eurozone economy as the U.S. and Israel attacked Iran, and its situation in 2022.
"The macroeconomic backdrop today is more benign," she said. "Headline inflation has been close to our target for almost a year. The unemployment rate is low by historical standards but we no longer face acute labor shortages."
In its assessment of why inflation surged and remained stubbornly high in the wake of Russia's invasion of Ukraine, the ECB placed greater stress than the Federal Reserve on the role of wider profit margins.
Lagarde said policymakers will again be paying close attention to the pricing behavior of businesses.
"If firms increase their selling prices disproportionately--as we saw in 2022--it could trigger an equivalent response from workers, what I have called in the past 'tit-for-tat inflation'," she said.
Lagarde also cautioned European governments against providing support to all or most households if energy prices stay high, as many did in 2022 and 2023.
"Targeted government policies can help smooth the shock by reducing energy demand and compensating lower-income households," she said. "But broad-based and open-ended measures may add excessively to demand and strengthen the pass-through."
European households have responded to the series of shocks that have characterized the 2020s by boosting savings. Lagarde said the latest shock could reinforce that behavior and limit the persistence of higher inflation.
"If households increase precautionary saving as they budget for higher energy bills, it could point to a more limited pass-through," she said.
The ECB's policymakers next meet to set policy on April 30.
"In the period ahead, incoming information will give us greater clarity on how the conflict is likely to evolve and how the economy is responding," Lagarde said. "We will monitor developments closely and set monetary policy as appropriate to deliver on our target."
Write to Paul Hannon at paul.hannon@wsj.com
(END) Dow Jones Newswires
March 25, 2026 06:20 ET (10:20 GMT)
Copyright (c) 2026 Dow Jones & Company, Inc.
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