Downside risks to growth have intensified. We are committed to setting monetary policy to ensure that inflation stabilizes at our 2% target in the medium term. The war in the Middle East has led to a sharp increase in energy prices, pushing up inflation and weighing on economic sentiment. The implications of the war for medium-term inflation and economic activity will depend on the intensity, the duration of the energy price shock, and the scale of its indirect and second-round effects. The longer the war continues, and the longer energy prices remain high, the stronger is the likely impact on broader inflation and the economy. We remain well-positioned to navigate the current uncertainty. The euro area entered this period of surging energy prices with inflation at around our 2% target, and the economy has shown resilience over recent quarters. Longer-term inflation expectations remain well-anchored, although inflation expectations over shorter horizons have moved up significantly. We will closely monitor the situation and follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance. In particular, our interest rate decisions will be based on our assessment of the inflation outlook and the risks surrounding it in light of the incoming economic and financial data, as well as the dynamics of underlying inflation and the strength of monetary policy transmission. We are not pre-committing to a particular rate. The decisions taken today are set out in a press release that is available on our website. And I will now outline in more details how we see the economy and inflation developing, and will then explain our assessment of financial and monetary conditions.
The euro area economy was showing some momentum when the current turbulence started. Real GDP grew by 0.1% in the first quarter of 2026, according to Eurostat's preliminary flash estimate. Domestic demand remains the main driver of growth, supported by a resilient labor market. However, the economic outlook is highly uncertain and will depend on how long the war in the Middle East lasts, and how strongly it affects energy and other commodity markets, as well as global supply chains. The incoming information suggests that the conflict is weighing on economic activity. Surveys point to slowing growth, and consumers and businesses have become less confident about the future since the war began. Longer delivery times and rising input prices suggest supply chains are coming under pressure. Looking ahead, high energy costs are expected to continue to weigh on real incomes, making households and firms more reluctant to consume and invest. While unemployment remained close to historical lows in March at 6.2%, labor demand has cooled further. At the same time, households are still benefiting from a solid financial position, and investment should continue to be underpinned by governments spending more on defense and infrastructure, and by firms increasingly investing in new digital technologies. This favorable starting point provides some cushioning against the fallout from the war.
The Governing Council highlights the urgent need to strengthen the euro area economy while maintaining sound public finances. Fiscal responses to the energy price shock should be temporary, targeted, and tailored. Reforms to enhance the euro area's growth potential and accelerate the energy transition to reduce reliance on fossil fuels are more vital than ever. Completing the savings and investment union is key to funding innovation, supporting the green and digital transitions, and improving productivity. The digital euro and tokenized wholesale central bank money will enhance Europe's strategic autonomy, competitiveness, and financial integration, and will boost innovation in payments. It is thus essential to swiftly adopt the regulation on the establishment of the digital euro. Simplifying and harmonizing rules across the EU's single market will help European firms grow faster.
Inflation rose to 3% in April from 2.6% in March and 1.9% in February. The rise has been driven by surging energy prices caused by the war in the Middle East. Energy price inflation jumped to 10.9% in April after 5.1% in March. Food price inflation edged up to 2.5% in April. Inflation excluding energy and food decreased to 2.2% from 2.3% in March, reflecting a fall in services inflation, which declined to 3% from 3.2% in March. Goods inflation went up to 0.8% from 0.5% in March. Indicators of underlying inflation have changed little over recent months. For now, the ECB's wage tracker and surveys on wage expectations continue to indicate easing labor cost in the course of 2026. At the same time, surveys indicate an increase in other cost components and in selling price expectations. Inflation expectations have moved up significantly over shorter horizons. Most measures of longer-term inflation expectations stand at around 2%, supporting the stabilization of inflation around target in the medium term. The increase in energy prices will keep inflation well above 2% in the near term. As the period of high energy prices extends, the likely impact on broader inflation through indirect and second-round effects intensifies. We will therefore closely monitor the size and persistence of the energy price surge, and how it feeds through to price and wage setting, inflation expectations, and overall economic dynamics.
The risks to the growth outlook are to the downside. The war in the Middle East remains a downside risk to the euro area economy, adding to the volatile global policy environment. Prolonged disruption of the supply of energy could increase energy prices further and for longer than currently expected. These factors would erode incomes and make firms and households more reluctant to invest and spend. The drag on growth would intensify if the closure of major shipping routes were to cause acute shortages of key inputs that forced euro area firms to curtail output. A worsening of global financial market sentiment could further dampen demand. Additional frictions in international trade could exacerbate supply chain disruptions, reduce exports, and weaken consumption and investment. Other geopolitical tensions, in particular Russia's unjustified war against Ukraine, remain a major source of uncertainty. By contrast, growth could turn out to be higher if the economy proved to be more adaptable to the disruption caused by the war in the Middle East, or if the conflict were resolved more quickly than currently expected. Moreover, planned defense and infrastructure spending, reforms to enhance productivity, and euro area firms adopting new technologies may drive up growth by more than expected. New trade agreements and a deeper integration of the single market could also boost growth beyond current expectations.
The risks to the inflation outlook are to the upside. If energy prices were to rise by more and for longer than currently expected, euro area inflation would increase further. This could be reinforced and become more persistent if higher energy prices were to spill over by more than expected to other prices and to wages, if longer-term inflation expectations were to rise in response, or if global supply chains were disrupted more broadly. Ongoing trade tensions could also give rise to more fragmented global supply chains, curtail the supply of critical raw materials, and worsen capacity constraints in the euro area economy. By contrast, inflation could turn out to be lower if the economic effects of the war in the Middle East prove to be more short-lived than currently expected or if indirect and second-round effects proved less pronounced. More volatile and risk-averse financial markets could weigh on demand and thereby lower inflation as well.
The war in the Middle East has caused significant volatility in global financial markets. Overall, financial conditions remain tighter than before the war. The cost of issuing market-based debt rose to 3.9% in March from 3.5% in February. Bank lending rates to firms, based on data recorded prior to the war, edged down to 3.5% in February while mortgage rates remained at 3.4%. The annual growth rate of bank lending to firms increased to 3.2% in March from 3% in February, while the growth rate of corporate bond issuance fell to 3.9% from 4.5% in February. Credit standards for loans to firms tightened in the first quarter, as reported in our latest bank lending survey for the euro area. This tightening was due to banks becoming more concerned about the economic risks faced by their customers. Demand for loans to firms decreased slightly in the first quarter, especially for fixed investment. Mortgage lending grew by 3% in March after 3.1% in February amid a small tightening in credit standards and unchanged demand.
So, in conclusion, the Governing Council today decided to keep the three key ECB interest rates unchanged. We are committed to setting monetary policy to ensure that inflation stabilizes at our 2% target in the medium term. We will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance. Our interest rate decisions will be based on our assessment of the inflation outlook and the risks surrounding it in light of the incoming economic and financial data, as well as the dynamics of underlying inflation and the strength of monetary policy transmission. We are not pre-committing to a particular rate path. In any case, we stand ready to adjust all of our instruments within our mandate to ensure that inflation stabilizes sustainably at our medium-term target and to preserve the smooth functioning of monetary policy transmission. And we are now ready to take your questions. And the first question goes to Mark Schoiswohl of Bloomberg. Mark, please.
Yes, thank you. President Lagarde, the statement says that the upside risks to inflation and the downside risks to growth have intensified. Where does this leave the ECB, this new risk assessment leave the ECB between its baseline, its adverse, and the severe scenario? And what does it mean for monetary policy ahead? And related to that, would you say that a rate hike in June, as expected by markets and most economists, is indeed the most likely outcome unless there is a quick end to the war and energy prices fall significantly? Thank you.
I think we would all wish that there was a quick end to the war. But looking at our monetary policy and the decision that we made today, we decided to keep the three interest rates unchanged. And to address your question, I'm not going to tell you whether we are closer to the baseline, scenario one, scenario two. Because I think that what we have debated over the course of yesterday and today with the Governing Council is where are we relative to the baseline? And the conclusion is that we are certainly moving away from the baseline. Where to exactly, at what point in between baseline and other scenarios is I'm not sure, you know, the most relevant assessment. We are moving away from the baseline. And what is critically important is the impact that energy prices will have. I said last time in March that it would be a question of the duration, the depth, and the propagation. And this is clearly what we need to better assess. If I was to summarize for you what we decided today, I would say that we made an informed decision on the basis of yet insufficient information. So, why do I say it's an informed decision? It's because we debated at length and in depth various options. We debated the decision that we have unanimously taken today, but we also debated at length and in depth a decision to possibly hike. So, that was debated amongst all governors. And I'm sure that you will meet some governors who will argue both sides or maybe one side of both proposals. So, it was really a deeply discussed monetary policy stance, of which the outcome was a unanimous decision to leave the three interest rates unchanged. And I'm saying that it's an informed decision based on insufficient information. It is caused by the fact that while the hard data is broadly in line with our projection and what we discussed here back in March, but there is such uncertainty that we need to understand and revisit all of that at our next monetary policy meeting. And we believe that given the position we are in, we are saying in the monetary policy statement that we started from a good position. We were well positioned to navigate. So, given that position, we believe that this six weeks will be the right time to assess the development, to understand in particular the outcome, possibly, of the conflict or if there is no outcome, that in and of itself will be informative, in order to make an informed decision on verified and revisited information that we will receive in the next six weeks. That's the clearest way, I hope it was clear, that I can describe for the really good discussions that we had both yesterday and today.
Next question to Annetta Weissbach of CNBC. Annetta, please.
President Lagarde, thank you for taking my questions. I have a question on whether you have also discussed the risk of a stagflationary scenario in the euro area and how that discussion went. And also, in the US, they are starting to also think about shrinking the balance sheet instead of using interest rate as a monetary policy instrument. Do you look into using other instruments as well instead of just hiking to alleviate the pressure from the price pressure and also help perhaps the economy? Thank you.
Well, thank you for your two questions. On the first one, you know, we take the view that the word, I mean, it's quite popular to talk about stagflation, and it flags a lot of anxiety and all the rest of it. I think we have determined that stagflation is the right characterization of what happened in the '70s. But from our perspective, we think that it's better to park it in the '70s, given the facts that we have at the moment. You know, it's a completely different situation. In the '70s, you had inflation continuing, continuing, continuing at a, you know, sort of sustainable and solid pace. You had very high unemployment. You had a monetary and fiscal framework that had nothing to do with what we have at the moment. So, we don't apply stagflation, that flashy term, to the circumstances that we have, because we really think that it's associated with the '70s situation. On the tools, you know, we have a whole series of tools in our toolbox. But certainly from our perspective, and given the data that we have and the kind of shock that we're facing, we believe that the interest rates is still the best tool that we can use, and that we have debated in the course of yesterday and today. Thank you.
Francesco Canepa of Reuters. Francesco, please.
Thank you very much. So, first question about your reaction function. Could you unpack a little the relative weight that you attach to growth and inflation in your reaction function? And second, about the scenarios. Did you update them? And if so, what do they look like now? And why, if I may, do you not think it relevant to say where we are now compared to the baseline and the two scenarios? Thanks.
I'm so pleased that you mentioned the reaction function. Because it's, you know, we spend quite a lot of time working it out, finding consensus around the reaction function. And as you know, because you're a frequent reader and observer of what we do, the reaction function has been very clearly spelled out in our strategy review that we published in 2021, and that I have tried to elaborate on and that I have tried to apply to the current circumstances in both my speech to the watchers and my speech in Berlin last week. So, I think for me, there are sort of three pillars, you know. But I have for myself three anchors of what our reaction function is. So, first of all, to remind you, target is 2% medium term, number one. Number two, symmetry. We discussed that today. It's and we reaffirmed it. Number three, our reaction will depend on the type of deviation from target that we observe. Is it large and sustainable? In that case, obviously, we have calibrated in our strategy review and in those two speeches that I have committed in the last few days, in that case, we have a forceful or persistent reaction to return inflation to our target of 2% medium term. That's our reaction function. And the data and the process that we use in order to deliver on that reaction function is what you see, monetary policy statement after monetary policy statement, which is the inflation outlook with the risks associated to it. And as you will have seen, in the MPS, we have a strong chapter on both risks to growth and risk to inflation. That's how we bring in the risk to growth, to your point. We also look at underlying inflation, and we look at the dynamics of monetary policy transmission. So, the reaction function, the process and the tools that we use in order to apply that reaction function, and of course, we look at the specificity of what we are going through. And that's where you will find more details in both my speech to the watchers, you are one of them, I'm sure, and my speech in Berlin to the bankers. And I think I tried in those two documents, particularly the latter, to really apply the reaction function and the tools to the circumstances through which we're going, in particular, a supply shock, a strong supply shock, negative one, of course, and to see whether we are going to use one or the other approach in order to deliver on our target of 2% medium term. And one is see-through. Anyway, I don't need to repeat my Berlin speech. Some of you have read it. The scenarios. Oh, yeah. You asked me about the scenarios. So, we constantly monitor. We constantly take in new data, hard data, soft data, survey results from all sorts of perspectives, and we verify, and we adjust, and we take stock of all that. In June, 6 weeks from now, you will be receiving not only the projections that our staff will produce, but you will also see the scenarios as revised and as updated as a result of the circumstances.
Turning now to the participants via video link, I'd like to give the floor to Isabella Bufacchi of Il Sole 24 Ore. Isabella, please.
Thank you for the opportunity. I have two questions on liquidity, which is a key to the implementation of monetary policy, but also crucial for financial stability in times of crisis like we have now. So, President Lagarde, euro area central bank reserves have almost halved from the peak in 2022 to 2.6 trillion in early 2026. And in the last bank lending survey, we found out that bank access to money market funding has deteriorated. So, has the Governing Council been looking at the design of new liquidity tools, as you had a question before on your toolbox? New liquidity tools in the operational framework, for example, new structural longer-term credit operations or structural portfolio of securities? And my second question is for Vice President Luis de Guindos. At the end of your 8-year mandate and 8 years of multiple crises, what is your assessment of the resilience of the banking system in terms of liquidity? And what about private credit players that do not have access to the ECB liquidity? Is all this enough? Thank you.
Well, thank you so much. We miss you here. But it's nice to see you. So, I'll take the first question, and then I'll give the floor to the Vice President. We still have abundance of liquidity. You mentioned 2.6. I think it's a little down from that number, but it's a significant amount of excess liquidity in the system. So, there is no shortage of liquidity. And as you know, we have a mechanism that works on the basis of access to liquidity, you know, it's a fixed interest rate full allotment, good collateral. It's working well, and we're not seeing any tension in that respect. Did we discuss new tools? The answer is no, because what we discussed, and it was on the agenda yesterday, we discussed the timetable and the methodology that will be adopted in-house by staff, as well as within the Eurosystem, bringing all the committees in the loop, to calibrate our operational framework to make sure that it is fit for purpose, and that it is good from a financial stability point of view, as well as from a proper functioning of the providing of liquidity, which is obviously one of the missions that we have. With that, I'll turn the floor over to you, my dear Luis.
Thank you very much, President. Good afternoon to everyone. Well, we have no doubts about the liquidity position and the capital position of the European banks. The European banks are resilient and we do not believe that liquidity or capital is any sort of limitation for lending and this is something that you know we have analyzed quite in detail. So I would say that we are confident that they have enough liquidity, that they have enough capital and that they are meeting the needs and the financial needs of families, households and corporates. You referred to private credit. Well, we are going to dedicate a full chapter of our financial stability review to private credit. It's something that is catching the eye of markets because of some liquidity issues. Private credit is a totally different animal in comparison with the banks in terms of oversight, in terms of the way that they function, and we are going to analyze interlinkages between private credit and other players such as insurance companies, the banks, and with private equity. And I think that you will have a full explanation of our approach and our assessment of the potential financial stability risks posed by the private credit in our financial stability review that is going to be published in three weeks.
Next question. Sorry, next question goes to Olaf with the Financial Times. Olaf, please.
Thanks for taking my questions. My first question is on a scenario that some economists discuss at the moment which is basically a return to the 2011 scenario where the ECB hiked relatively early on then had to reverse after finding out that it basically pushed the economy further into stagnation. Is this a scenario which is on the top of the governing council's mind and has it been discussed? What are your thoughts on that? And my second question is also to the vice president on cross-border banking mergers in the euro area which has been I think kind of a favorite topic of the ECB in recent years. We now have a situation where the German government is quite openly opposing a potential merger. Do you have any views on those kind of action of the German government or what at least the position? Thanks.
