Nagel clarifies ECB's reaction to low inflation scenarios
Bundesbank President Joachim Nagel explained the European Central Bank's monetary policy framework for reacting to inflation deviations. Speaking at the Karlsruhe Institute of Technology, he clarified when the ECB would adjust interest rates in response to inflation falling below target.
Navigating the inflation thermostat
The primary objective of the euro area central banks is to maintain price stability, defined by the ECB Governing Council as 2% inflation over the medium term.
This target is symmetric, meaning both positive and negative deviations are equally undesirable.
Monetary policy operates with a significant time lag, typically 12 to 18 months, making immediate responses to short-term inflation changes often counterproductive.
The medium-term orientation also accounts for temporary fluctuations, such as those in energy and food prices.
However, monetary policy must respond decisively if there is a risk of long-term inflation expectations becoming unanchored.
The ECB's interest rate decisions are guided by three factors: the inflation outlook, underlying inflation dynamics, and the strength of monetary policy transmission.
From theory to today's numbers
The euro area experienced significant inflation volatility, from below 2% pre-pandemic to a peak of 10.6% in October 2022. The ECB responded with ten rate hikes, raising the deposit facility rate to 4%, before easing to 2% by June 2025. In January 2026, euro area inflation stood at 1.7%.
Eurosystem staff projections from December 2025 anticipate inflation slightly undershooting the 2% target in 2026 and 2027, before returning to target in 2028. Risks to this outlook are balanced, and long-term inflation expectations remain firmly anchored.
Core inflation, excluding energy and food, also shows a similar path, with services inflation, driven by wage growth, contributing strongly.
Monetary policy transmission is largely in line with historical patterns.
Patience meets vigilance
Nagel's speech highlights the ECB's commitment to a data-dependent, medium-term approach, avoiding knee-jerk reactions to minor, volatile inflation dips.
Despite current inflation being below target, the emphasis on anchored expectations and a projected return to 2% suggests no immediate policy shift.
This nuanced stance balances stability with the flexibility to act if underlying inflationary pressures or expectations truly unanchor.