Monetary policy in times of geopolitical tensions and technological disruption

(Slides, PDF)

The euro area economy has shown resilience and performed somewhat better than expected despite the tensions in the Middle East. Expectations for growth in the rest of the year have also strengthened compared to earlier projections.

Irish GDP figures, however, complicate the interpretation of latest statistical estimates, as the activities of multinational enterprises in Ireland add significant volatility to quarterly euro area growth figures. Revised euro area growth in the second quarter was 0.6%. But an adjusted measure that uses modified domestic demand instead of GDP for Ireland shows a stable moderate quarterly growth of 0.3% during the first half of the year.

Economic activity is supported by increased investment in defence and infrastructure. At the same time, private consumption has proven more resilient than anticipated. Moreover, the expansion of artificial intelligence-related activity is becoming increasingly visible in the euro area economy, notably through digital services, business investment and export activity.

In September, the ECB revised its growth projections for the euro area upwards. The euro area economy is now expected to expand by just under 1% this year (0.9%), followed by growth of around one and a half percent in each of the following two years (1.4% and 1.5%, respectively). Nonetheless, the continuation and possible escalation of the conflict in the Middle East continues to pose downside risks to the growth outlook.

The outlook is also influenced by tighter financing conditions. Rising interest rates and interest rate expectations, together with other factors that have contributed to a higher general level of borrowing costs, have led to an increase in bank lending rates for both households and firms.

Although loan stocks in the euro area have continued to grow in recent months, the tightening of financing conditions may increasingly weigh on credit demand and, consequently, dampen economic growth and reduce inflationary pressures in the period ahead.

Turning to inflation developments, inflation was 3.8 percent in September, driven by energy price inflation which was 18.9 percent. In addition to higher energy commodity prices, refining and redistribution margins have recently pushed up the consumer price of energy. Inflation excluding energy and food prices, i.e. core inflation, was 2.5% in September. 

The recent increase in inflation continues to be driven primarily by higher energy prices stemming from the conflict in the Middle East. According to the ECB’s September projections, headline inflation is expected to remain above the 2% target on average next year, with core inflation projected at 2.6%. Thereafter, inflation is expected to gradually stabilise towards the target by decreasing to 2.1% in 2028, while core inflation is projected to moderate to 2.3%.

The future path of inflation will depend to a significant degree on how the situation in the Middle East evolves and how the energy shock propagates to the rest of the economy. At our December meeting, we will have on the table updated macroeconomic projections, providing a comprehensive assessment of the medium-term inflation outlook and a detailed analysis of developments in the euro area economy.

This chart shows that inflation has increased in a relatively small number of predominantly energy-related categories, rather than being spread across the consumption basket. Only 19 of the 136 HICP sub-components recorded inflation rates exceeding 5% similar to the average observed in 2025. Overall, the share of items with an inflation rate above 3% has remained broadly unchanged since the beginning of 2024.

The chart here shows that the acceleration in inflation continues to be concentrated on goods and services that are directly or indirectly linked to energy prices, such as fuels, electricity and transport services. By contrast, prices for other categories have, on average, not increased materially since the escalation of the conflict in the Middle East.

Inflation therefore does not, at least for the time being, appear to have become broad-based.

The cyclical position of the economy will play a key role in determining whether price pressures spread more widely across the economy. In 2022, when Russia launched its invasion of Ukraine and triggered a sharp increase in energy prices, the euro area economy was in the midst of a rapid recovery from the most severe phase of the pandemic.

Today, the situation is different. Even as economic activity has surprised somewhat on the upside, overall growth momentum remains relatively subdued. Labour market conditions in the euro area also differ markedly from those prevailing during the previous energy crisis. Demand for labour has softened over the past couple of years, and labour markets can no longer be characterized as particularly tight.

Consistently, wage growth has remained relatively moderate and has, in fact, eased further across the euro area. Thus, there is as of yet little evidence of second-round effects feeding through higher energy prices to underlying inflation dynamics.

At its September meeting, the ECB increased its key interest rates by 0.25 percentage points. The inflation outlook for the euro area and the risks surrounding it warranted a rate hike. Headline inflation remains clearly above the ECB’s 2 percent target, and the crisis in the Middle East continues to generate price pressures. The September rate hike supports the stabilization of inflation back towards the target.

Let me say a few words about the ECB’s framework for making monetary policy.

Our interest rate decisions are based, in particular, on our assessment of the inflation outlook and the risks surrounding it, the dynamics of underlying inflation, and the strength of monetary policy transmission.

The ECB does not commit in advance to any specific interest rate path; instead, it takes decisions on a meeting-by-meeting basis, always drawing on the latest data, comprehensive analysis and overall judgment. In my view, this approach is well-founded given the huge uncertainty of the current situation.

In our analysis, identifying broader price pressures in the economy and understanding the deeper dynamics of inflation is more important than short-term fluctuations in energy prices.

Looking ahead, our monetary policy response will depend on whether we see more broad-based effects on inflation. So far, we have not seen second-round effects. But we must be mindful of recent experiences, as they may creep in, which requires continued vigilance.

To conclude, I want to emphasize the actions that Europe must take to tackle the current challenges. Europe's future will depend on whether we can deliver on three fronts: defence, energy and productivity.

First, Europe must take greater responsibility for its own defence as a European pillar of NATO. This requires more joint investment and procurement, so that higher spending translates effectively and efficiently into real capabilities to defend Europe together.

Second, Europe needs a broader range of non-fossil energy sources, suppliers and technologies — and greater investment in renewables and nuclear power. The green transition is not only about climate. It is fundamentally about Europe's energy security and economic resilience.

Third, Europe must boost its productivity growth and economic competitiveness. This requires investment in human capital, deeper capital markets, less red tape, more innovation and entrepreneurship. The single most actionable step today is delivering the Savings and Investments Union to unlock private capital at scale and ensure that our most innovative firms can grow and stay in Europe.

All three need big investments. But where will the money come from?

Europe has the savings. What it lacks is an integrated, deep and liquid financial market. Our savings sit in twenty-seven separate mattresses. The Savings and Investments Union should be completed without delay, to channel the Europeans’ substantial saving into productive investment.

The choices made in these three areas, both at EU level and by Member States, will shape Europe’s economic future and strategic capacity to act.

In this context, monetary policy will act with a steady hand and ensure price stability, thus supporting sustainable growth and job creation.

Thank you very much for your attention.