European Central Bank President Christine Lagarde said on Thursday that the current rise in euro area inflation is likely to be temporary and underlying price pressures are expected to pick up gradually. Yet, inflation over the medium term is likely to remain well below the target, she added.
On July 8, the ECB had adopted a symmetric 2 percent inflation target that will allow a temporary overshoot in inflation, following a monetary policy review that was launched last year.
Earlier on Thursday, the bank left its key interest rates unchanged, but revised the forward guidance on the same to support its symmetric inflation target. Policymakers now expect ECB interest rates to remain at their present or lower levels until inflation "durably" reaches two per cent well ahead of the end of its projection horizon. The bank also guided to a transitory period in which inflation is moderately above target.
Economists widely saw the revised forward guidance as a shift towards more dovishness and a clear message that Eurozone interest rates are set to remain low for a long time. The ECB expects inflation to increase further over the coming months and to decline again next year. The current increase is largely being driven by higher energy prices and by base effects from the sharp fall in oil prices at the start of the pandemic and the impact of the temporary VAT reduction in Germany last year, Lagarde said. By early 2022, the impact of these factors should fade out as they fall out of the year-on-year inflation calculation, the bank said.
While stronger demand and temporary cost pressures in the supply chain are set to push prices higher, weak wage growth and the past appreciation of the euro are expected to keep inflationary pressures subdued. "There is still some way to go before the fallout from the pandemic on inflation is eliminated," Lagarde said.
"While measures of longer-term inflation expectations have increased, they remain some distance from our two per cent target," she said.
The bank expects Eurozone economic activity to return to its pre-crisis level in the first quarter of next year.
"We see the risks to the economic outlook as broadly balanced," the ECB chief said.
"Economic activity could outperform our expectations if consumers spend more than currently expected and draw more rapidly on the savings they have built up during the pandemic."
A faster improvement in the pandemic situation could also lead to a stronger expansion than currently envisaged, she said. However, growth could be below expectations if the pandemic intensifies or if supply shortages turn out to be more persistent and hold back production, Lagarde warned.