European Central Bank President Christine Lagarde has issued a stark warning about the challenges ahead, arguing that abrupt shifts in global trade patterns and the evolving defense architecture of Europe will significantly complicate the ECB’s efforts to maintain price stability.
Speaking at a conference in Frankfurt, Lagarde characterized these changes as “two-sided shocks” that, along with the escalating threat of climate change, are poised to reshape the landscape of monetary policy.
“Maintaining stability in a new era will be a formidable task,” she stated on Wednesday, acknowledging the unprecedented challenges facing central bankers in the current global environment.
Tariffs, defense, and climate: a perfect storm
Lagarde emphasized the need for a nuanced and adaptable approach to monetary policy.
With officials confident that inflation will return to their 2% target by early next year, attention is now turning to the long-term implications of these emerging trends.
“Trade fragmentation and higher defense spending in a capacity-constrained sector could in principle push up inflation,” Lagarde explained.
However, she also cautioned that “Yet US tariffs could also lower demand for EU exports and redirect excess capacity from China into Europe, which could push inflation down,” highlighting the unpredictable nature of these economic forces.
The 2% commitment
Despite the inherent complexities, Lagarde reiterated the ECB’s unwavering commitment to its primary objective.
Regardless of the shocks, “we must set our policy appropriately so that inflation is always converging back towards 2% over the medium term,” she stated, underscoring the central bank’s determination to maintain price stability.
To better equip itself for this new era of instability, the ECB will undertake a comprehensive review of its monetary-policy strategy in the second half of 2025.
While less extensive than a previous review completed in 2021, this exercise could still have significant implications for future interest rate decisions and the central bank’s response to potential crises.
Officials are actively investigating the most effective ways to respond to supply shocks, should such events become more frequent and persistent.
In the past, central bankers often disregarded supply shocks, viewing them as temporary disruptions with limited long-term impact on price growth.
However, recent years have revealed the potential for these shocks to become larger and more persistent, leading to a divergence of price expectations from the central bank’s target, regardless of whether the shocks are supply- or demand-driven.
Lagarde’s predecessors have faced criticism for underestimating the persistence of inflationary pressures in 2021 and for acting too slowly to raise interest rates and halt net asset purchases in the following year.
“Within a well-articulated strategy and an unwavering commitment to price stability, we will need to retain agility to respond to complex circumstances as they arise,” Lagarde concluded, emphasizing the need for both steadfastness and adaptability in the face of unprecedented challenges.
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