Lagarde opens to possible ECB rate hike if inflation rises due to energy shock

Even a "not too persistent" overshooting of the European Central Bank inflation target, caused by the current energy shock, could justify a moderate tightening of monetary policy, says ECB Governor Christine Lagarde. The ECB left rates unchanged the last week, but warned of an imminent price hike and policymakers are now discussing under which scenario interest rates would need to be raised to counter the risk of rapid price growth.

"Should the shock result in a significant, though not too persistent, overshooting of our target, a measured adjustment of monetary policy might be warranted," Lagarde said in a speech in Frankfurt. "Completely ignoring such an overshooting could pose a communication risk: the public might find it difficult to understand an unresponsive reaction function," she argued.

Lagarde did not explicitly equate her criteria to any of the scenarios outlined by the ECB last week. However, they are not too different from the inflation trajectory in the bank's 'adverse' scenario. In the ECB's most favourable 'baseline' scenario, inflation will average 2.6 per cent this year, up from around 2 per cent last year.