Lagarde says energy shock too big to ignore as ECB weighs measured response

Lagarde says energy shock too big to ignore as ECB weighs measured response

The European Central Bank has raised interest rates by 25 basis points in September, following an identical increase in June, President Christine Lagarde told the International Monetary and Financial Committee at the IMF Annual Meetings in Washington on 17 October 2026, saying the energy shock is too large to "look through" but that a measured response remains appropriate. Euro area headline inflation reached 3.8% in September, the ECB president said, with core inflation at 2.5%.

Key facts

How resilient is the euro area economy?

Lagarde said the euro area has so far withstood global headwinds and the ongoing energy shock, with growth broad-based across most countries and sectors in the first half of 2026. The September ECB staff projections point to growth of 0.9% in 2026, 1.4% in 2027 and 1.5% in 2028.

Domestic demand should benefit as the energy shock fades and real incomes recover, helped by lower energy inflation and a resilient labour market, she said. Rising government spending on infrastructure and defence, together with investment in artificial intelligence and digital technologies, is also expected to support growth, while export growth should pick up on strengthening foreign demand.

Risks to growth are assessed to be on the downside, with uncertainty over how intense and long-lasting the Middle East conflict will be and how its shocks might propagate through the economy.

What is driving inflation?

Headline inflation climbed to 3.8% in September, mostly reflecting a surge in energy inflation and, to a lesser extent, higher food and services inflation. Core inflation edged up to 2.5%, and the range of underlying measures was broadly stable, with wages showing no material response to the energy shock so far.

Higher energy prices are expected to keep headline inflation well above target into the first half of 2027 and to feed gradually into core and food inflation. Lagarde said headline inflation should decline after the first quarter of 2027 as energy inflation falls, returning to around target towards the end of the year.

Risks to inflation are tilted to the upside, she said, citing the Middle East conflict and Russia's war against Ukraine. A more intense or persistent energy shock could strengthen second-round effects and make inflation more persistent, while extreme weather could push up food prices. By contrast, a sustainable resolution of geopolitical conflicts, weaker energy pass-through or more risk-averse financial markets could lower inflation.

Why raise rates now?

Lagarde said the Governing Council's decisions rest on three criteria: the inflation outlook and the risks around it, the dynamics of underlying inflation, and the strength of monetary policy transmission.

She said the inflation outlook points to higher prices ahead, especially in the short term, but that there is no evidence at this stage of significant pass-through of energy prices to other prices and wages beyond what the ECB has already built into its projections. Financing conditions have tightened, with long-term interest rates rising notably since the last meeting, which should slow growth and reduce pass-through by more than projected in September.

"The energy shock is too large to 'look through' but a measured response remains appropriate to keep inflation in check," Lagarde said, adding that future policy will rest on a comprehensive assessment of incoming data.

What does the ECB want from governments?

Lagarde called fiscal sustainability a crucial anchor for broader economic stability, urging governments to keep sound fiscal policies, adhere to fiscal rules and, where debt is high, to consolidate, re-prioritise spending and improve the efficiency of public finances to rebuild buffers. Any fiscal response to the energy shock should be temporary, targeted and tailored, she said.

She also pointed to structural priorities: advancing the savings and investments union, improving access to risk capital and creating better conditions for innovative firms to scale up across the Single Market, alongside policies to boost labour market participation, equip workers with skills for an AI-driven economy and spread new technologies.

On the global picture, Lagarde said the world economy has proved surprisingly resilient despite high uncertainty, helped in part by investment in artificial intelligence, though trade tensions and protectionist measures are weighing on confidence and reconfiguring trade flows.

What happens next?

Lagarde said the Governing Council will make a comprehensive assessment of incoming data based on its reaction function when setting future policy. In July, the council set the operational features and onboarding process for the enhanced EUREP, the Eurosystem repo facility for central banks, which she said supports the smooth transmission of monetary policy and reinforces the euro's international role.

Source: European Central Bank

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