The path back to 2 % has become less comfortable

Good evening and thank you for having me here this evening.

You asked me to say a few words on the outlook for the euro area economy and inflation. 

I am also very conscious that I am the only thing standing between you and the main course, so I have a strong incentive to keep this brief. 

If I had to sum up my main takeaway from last week’s ECB Governing Council meeting in one sentence, it would be this: the renewed energy shock has made the outlook more uncomfortable, but it has not – at least so far – fundamentally changed the underlying inflation picture.

Let me explain what I mean.

Euro area inflation rose to 3.8 per cent in September, largely because of higher energy prices. Oil prices have increased and European gas prices have risen markedly. So the first-round effect of the energy shock is already clearly visible.

But for monetary policy, the more important question is what happens next.

Higher energy prices can lift headline inflation quite quickly. What matters for monetary policy is whether they start to affect a much broader range of prices and wages, and ultimately inflation expectations. In other words, the issue is not whether the energy shock raises inflation. It does. The issue is whether it becomes persistent.

So far, the evidence of broader and more persistent effects remains limited.

Underlying inflation has remained broadly stable. Wage developments do not yet show a material response to the energy shock. Medium- and longer-term inflation expectations remain anchored. And labour market tightness has eased from the exceptionally high levels we saw after the pandemic.

That does not mean we can ignore the shock. Quite the opposite. Its magnitude and duration have increased, and that clearly raises the upside risks to inflation. But it does mean that we should distinguish carefully between a rise in headline inflation and a lasting change in the inflation process.

The growth side of the story is almost the mirror image.

The euro area economy has remained more resilient than one might have expected given the shocks it has faced. Activity has continued to expand. AI-related investment and digitalisation are providing support, as is higher public spending on infrastructure and defence.

At the same time, the headwinds are real. Higher energy prices reduce households’ purchasing power and raise firms’ costs. Long-term interest rates have risen. Financing conditions have tightened. And consumer confidence has weakened.

So we are dealing with a shock that pushes inflation up in the near term while at the same time weighing on growth. That is precisely the kind of environment in which monetary policy becomes less mechanical.

The Governing Council therefore kept the key ECB interest rates unchanged last week.

For me, the interesting point is not so much the decision itself as the reasoning behind it. When uncertainty is high, there is a temptation to look for a simple rule: oil up, rates up; growth down, rates down. Unfortunately, the economy does not give us that luxury.

We need to ask which effects are likely to persist. We need to look at underlying inflation and wages, assess how strongly tighter financial conditions are already working through the economy, and judge the balance of risks to inflation over the medium term. 

That is why the Governing Council continues to take decisions meeting by meeting and on the basis of incoming data.

Data dependence is sometimes interpreted as a lack of direction. I would see it almost the opposite way: when the shocks hitting the economy can pull inflation and growth in different directions, pre-committing to a rate path would create a false sense of precision.

By the December meeting we will have new projections, more inflation and wage data, and more evidence on the effects of the energy shock. We will know more – although almost certainly not everything.

And perhaps that is also the most relevant message for a table filled with financial-market participants. Markets have to price a path every day. Central banks do not. Our task is to keep the medium-term objective clear while retaining the flexibility to respond as the evidence changes.

The objective is unchanged: inflation at two per cent over the medium term. So, in this sense, the direction is always clear – back to 2%. It is the path that is uncertain. And that path has simply become somewhat less comfortable again.

With that, I will stop and leave the rest for discussion over the main course.