Lagarde Says ECB Rate Peak Must Ensure Inflation Goes to 2%

(Bloomberg) -- European Central Bank President Christine Lagarde said the peak of the current cycle of interest-rate increases must ensure that inflation returns to the 2% target over the medium term.

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Without specifying a level for the so-called terminal rate, Lagarde said borrowing costs have further to rise following last week’s second straight 75 basis-point hike.

“The destination is clear, and we haven’t reached it yet,” she told the Latvian website Delfi Bizness in an interview published Tuesday.

Inflation in the 19-member euro zone hit a record 10.7% in October, overshooting analyst estimates even as economic growth weakened and many predict a downturn during the winter as Russia cuts energy deliveries.

Lagarde acknowledged that the likelihood of a recession has increased but warned of the dangers of not stepping in to tame inflation, calling stable prices “the basis for a smoothly functioning economy in which everyone benefits.”

“Inflation is still too high throughout the eurozone,” she said. “The longer inflation remains at this high level, the greater the risk that it will spread throughout the economy. Then consumers and businesses will also begin to expect higher inflation in the future, and this is dangerous.”

As rising interest rates boost mortgage bills and hurt corporate borrowers, Lagarde said banks are in a stronger position than they were in the runup to the 2008 crisis. Even so, “complacency must not be allowed,” she said.

Model Limits

During the current cost-of-living squeeze, governments must be careful to make sure any fiscal aid is temporary and targeted at those that need it most, Lagarde said.

Executive Board member Isabel Schnabel meanwhile told Germany’s Deutschlandfunk Kultur radio that the ECB is trying to “get a grip on inflation dynamics,” with interest rates as the primary instrument.

She also said economic models that the ECB uses to forecast price growth have their limits at a time when the geopolitical situation and the mechanics of global trade are changing.

“It’s not that we’re convinced that every assumption in the model is perfect -- we’re constantly trying to improve the models,” Schnabel said. “But you also have to know their limits.”

--With assistance from Alexander Weber.

(Updates with comment from ECB’s Schnabel starting in ninth paragraph.)

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