Christine Lagarde0:00
The decision that we took today to raise by 25 basis points our three interest rates was a unanimous decision without reservations. There will be no preset rate path in our considerations, and as a result of that, it will be what it will be. Our discussion were predicated on obviously the major energy shock that we have observed since the beginning of March, that is enduring longer than what was expected by geopolitical experts. The governing council is committed to setting monetary policy to ensure that inflation stabilizes at our 2% target in the medium-term. In line with this commitment, we today decided to raise the three key ECB interest rates by 25 basis points. The war in the Middle East is generating inflation pressures, and the decision to raise rates is robust across a range of scenarios, mapping out how the shock might evolve and affect the medium-term outlook for the euro area. In the baseline of the new euro system staff projections, headline inflation is expected to average 3% in 2026, 2.3% in 2027, and 2% in 2028. For inflation excluding energy and food, the baseline foresees an average of 2.5% in 2026 and 2027, and 2.2% in 2028. Compared with March, staff have revised up their baseline projection for inflation in 2026 and 2027 owing to a higher path for energy prices, which to some extent is expected to feed into food, goods, and services inflation. The baseline sees economic growth at an average of 0.8% in 2026, 1.2% in 2027, and 1.5% in 2028. This is a downward revision for 2026 and 2027, reflecting a more pronounced impact of the war on commodity markets, real incomes, and also confidence. The outlook remains uncertain with upside risks for inflation and downside risks for economic growth. The full implication of the war for medium-term inflation and growth will depend on the intensity and duration of the energy price shock, as well as the scale of its indirect and second round effects. This uncertainty is also reflected in the broad range of outcomes for inflation and growth in the updated illustrative scenarios put together by Euro system staff. These will be published with the staff projections on our website. With today's decision, we remain well positioned to navigate the uncertainty caused by the war. 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 path. It is becoming more expensive for firms to source other inputs, and they therefore expect to put up their selling prices. Moreover, some indicators of underlying inflation have already been driven higher by the energy shock. Inflation expectations over shorter horizons remain well above levels before the outbreak of the war in the Middle East. At the same time, 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 lift inflation further over the summer and keep it well above target into the first half of 2027. It will also have an impact on food, goods, and services inflation. Inflation should then return to target in the second half of 2027, supported by falling energy prices and slower increases in other prices. However, the war in the Middle East remains a major source of uncertainty, and the longer energy prices stay high, the more likely they are to drive up broader inflation through indirect and second round effects. We will therefore closely monitor the size and persistence of the energy price increase and how it feeds through to price and wage setting, inflation expectations, and overall economic dynamics. 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 and energy markets were to adapt more quickly than expected to the disruption caused by the war in the Middle East, or if the war was resolved promptly and sustainably. 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. A deeper integration of the single market would also boost growth beyond current expectations. The risks now 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. Extreme weather events and the unfolding climate and nature crisis more broadly could drive up food prices by more than expected. By contrast, inflation could turn out to be somewhat lower if the economic effects of the war in the Middle East proved to be more short-lived than currently expected, or if indirect or second round effects prove less pronounced than anticipated. More volatile and risk-averse financial markets could weigh on demand and thereby lower inflation.
