Keynote by François Villeroy de Galhau on Monetary Policy

You want to walk? No, I won't walk but I will explain. Dear friends, dear CR, it's really my pleasure to welcome you all in the Bank of France and in Paris. Can I have a special mention for two of you? First my friend Philip Lane, who is another heavyweight in the governing council, and second for you, Philip, you are still with us for some minutes. Can I add my congratulations – we are in the Bank of France and in France you know it is very proud of your Nobel Prize. I had the privilege to know you for about 20 years and we are friends. That said, it's not that easy to succeed you on stage because you all noticed that Philip kept walking, spoke without any written notes, had a body language which was still more enthusiastic than usual. I am only a central banker, not a Nobel Prize. So I will keep standing and have a speech. But I hope on a complimentary topic which is probably the bedrock, the foundation for any innovative policy: this is trust, price stability. So I will speak about how monetary policy can navigate today's uncertainty. Let me start with the good news. Three years after reaching its peak, inflation is currently at 2.2% in the euro area and has been very close to target since May. And this disinflation was achieved without triggering a recession – an outcome many observers had considered unlikely. As Christine Lagarde has rightly and often observed, we are in a good place. But my theme today is that a good position is not a comfortable one nor a fixed one. First, claiming to be in a comfortable position in such an uncomfortable world would be excessive. True, uncertainty has eased, but it remains high: valuations, fiscal and political instability, trade shifts, geopolitical tensions, doubts over the US dollar's global role. Many of these uncertainties are Knightian – no well-defined probabilities. Hence diverging assessments across agents, and markets are less likely to stabilize. Consider recent developments: bond markets show tensions at the long end due to fiscal risk, while equity markets outperform. This suggests optimism in the short term but concerns about the longer term. The Brainard principle of caution may be counterproductive if agents expect systematic underreaction. So we need a risk-management approach. Our data-dependent, meeting-by-meeting approach is more than a mantra – it's my favorite notion of agile pragmatism. We combine a hard commitment to the 2% symmetric inflation target with a soft guidance on the interest rate path. Soft guidance is not unconditional forward guidance; it keeps optionality. We must also address other sources of uncertainty, such as deteriorating public finances and missed opportunities for structural reforms. I follow Philip in advocating full implementation of the Draghi report by January 2028, including a 28th regime for 2028. Now to the second point: it's not a fixed position. Let me dispel three misconceptions. First, our reaction function is symmetric – we do not tolerate inflation below target any more than above. Second, we react not to the size of deviations but to their persistence. Third, we are not Fed-driven; we led by European data. Our deposit rate is 2%, close to the natural rate; our balance sheet is larger than the Fed's. We are not following the Fed's quantitative tightening; we should speak of quantitative normalization. We will discuss the right size of the balance sheet next year. We need to maintain ample liquidity. The current excess liquidity of about 2,500 billion is above the floor required of about 1,500 billion. If liquidity becomes scarce, it could tighten credit. We can provide liquidity through short-term operations and a structural portfolio. The name of the game ahead is full optionality. Inflation is at 2.2% on average, but with significant heterogeneity – low in France (0.8%) and Italy (1.1%), higher in Germany (2.6%) and Spain (3.1%). This is driven by service inflation, which reflects wage dynamics. Once wage catch-up completes, we can expect lower service inflation. There are both upside risks (fragmentation, defense spending) and downside risks (weaker wage growth, stronger euro, cheap Chinese imports). The bottom line: downside risks on inflation are at least as significant as upside risks, and we will not tolerate a lasting undershooting. The only fixed figure is our 2% target, not any terminal rate. We don't exclude any policy action. Let me conclude with a tennis analogy from René Lacoste: being ahead does not give us permission to relax. As in a tennis match, it's not the last shot that matters, it's the next one. Agility is at the crossroads of extreme clarity about our determination to deliver the 2% target and pragmatic humility about our next shots. Thank you for your attention.