Lagarde sends mixed signals: Eurozone economy deviates from base scenario but ECB not inclined towards tightening.

European Central Bank President Lagarde said that the rise in energy costs has caused the eurozone economy to deviate from the ECB's baseline scenario expectations, but the current situation is not enough to make policymakers consider raising interest rates. On Tuesday, while attending the International Monetary Fund (IMF) spring meeting in Washington, Lagarde said in an interview that the European economy is currently caught between the baseline scenario and the stress scenario set by the central bank due to the impact of the conflict in the Middle East. When asked if this meant that the ECB was leaning towards tightening monetary policy, Lagarde denied it. She said, "Our policy core indicator is based on financial stability to achieve price stability." Against the backdrop of a six and a half week conflict in the Middle East causing soaring oil prices and dampened economic confidence, the ECB is cautiously evaluating future policy measures. The overall inflation rate in the eurozone has significantly exceeded the 2% policy target, with the core issue being the sustainability of this round of price increases. The market generally believes that an ECB rate hike is only a matter of time, but given the uncertain prospects of US-Iran talks, investors do not expect the central bank to raise interest rates at its next monetary policy meeting on April 29-30. Traders are currently betting that the ECB will implement two rate hikes of 25 basis points each within the year, with a 30% probability of a third rate hike; a week ago, the market even expected up to four rate hikes within the year. The yield on German two-year government bonds, sensitive to changes in monetary policy, fell by 11 basis points to 2.54%. Lagarde said, "We must remain highly flexible and be prepared to adjust policy direction as needed. As we have emphasized many times, decisions will be entirely data-dependent, but at the moment, the policy direction cannot be determined, and I cannot provide a clear interest rate path today." The IMF's latest forecasts released earlier on Tuesday may provide more clues. The forecast indicates that global inflation will accelerate, while growth will be weaker. In the eurozone, which has 21 member countries, consumer prices are expected to rise by 2.6% this year, in line with the ECB's own projections. However, as the conflict in the Middle East continues and the navigation situation in the Strait of Hormuz deteriorates, several ECB officials believe that the likelihood of the baseline scenario being realized is decreasing. If the situation worsens, the ECB's stress scenario may come true, with inflation peaking at 4.2%; if the situation further deteriorates, in an extreme scenario, the eurozone could experience a short-term recession, with inflation surging past 6%. Currently, ECB officials are closely monitoring the transmission effects of rising energy costs to other sectors of the economy, especially focusing on indicators such as wage demands. After the outbreak of the Russia-Ukraine conflict in 2022, eurozone inflation rates briefly exceeded 10%, followed by a significant increase in wage levels. Lagarde said, "We have made it clear that policy actions need to be supported by data, but when necessary, we will not hesitate to take measures. This accurately summarizes our position: we need to judge whether this round of inflation is a short-term pulse-like increase or if it will continue to ferment, although the latter seems unlikely to me." Later in the day, Lagarde reiterated a similar stance at a Bretton Woods Committee meeting in Washington. She said, "Based on the current situation, we need to evaluate data, assess the nature of the impact, the trend of changes, the extent of the impact, and the duration of it, and respond flexibly. It is undoubtedly a serious mistake to 'turn a blind eye' to the upward trend of inflation. At present, everything is still uncertain, and it is too early to draw conclusions. Once we have enough data and information, we will take action flexibly and decisively." She once again emphasized the ECB's determination to take action when necessary. "What I can assure is, first, we will never let inflation expectations become unanchored; secondly, we will adhere to and continue to practice our mission of price stability, which is to control inflation at the target level of 2% in the medium term."