Guindos Says ECB Sees Substantial Risks to Inflation Outlook

The European Central Bank (ECB) has made significant progress in bringing down inflation but continues to face substantial risks, according to Vice President Luis de Guindos. In a recent speech, Guindos highlighted several factors that could impact the ECB's inflation outlook, including geopolitical conflicts, wage growth, and fiscal support measures.

Geopolitical conflicts, particularly in the Middle East, pose a significant upside risk to inflation. These conflicts can disrupt energy supplies and global trade, pushing up energy prices and freight costs in the near term. The ECB must monitor these risks closely and adjust its monetary policy accordingly.

Sticky wage growth and uneven fiscal support measures could also influence inflation dynamics. High employment growth coupled with subdued output growth weighs on labor productivity, leading to increased unit labor costs. Meanwhile, restrictive monetary policy reduces firms' pricing power, slowing the pass-through of wages to prices. The ECB expects productivity to recover as activity strengthens, but these factors will continue to impact inflation in the medium term.

Past rate hikes may dampen demand and inflation more than expected, with weaker global growth serving as an added downside risk. The ECB must consider these factors when determining the appropriate level and duration of monetary policy restriction. The Governing Council will continue to follow a data-dependent approach, assessing the inflation outlook in light of incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.

The ECB's communication strategy and quantitative tightening will also influence market expectations and inflation. The Governing Council has been clear that all monetary policy instruments remain available to deliver sufficient liquidity to the banking system. The new operational framework, which came into force in September 2024, anticipates a substantial contribution to providing liquidity through a structural portfolio of securities and new longer-term refinancing operations.

In conclusion, the ECB faces substantial risks to its inflation outlook, including geopolitical conflicts, wage growth, and fiscal support measures. The Governing Council must carefully balance these risks with the need to support economic growth. By following a data-dependent approach and maintaining a flexible monetary policy, the ECB can help ensure that inflation returns to its 2% medium-term target in a timely manner.