In a keynote address delivered at the European Central Bank Conference on Monetary Policy in Frankfurt am Main, Executive Board member Philip R. Lane outlined the central diagnostic challenges involved in determining appropriate monetary policy stances. Interest rate decisions at the central bank are guided by three primary criteria: the assessment of the inflation outlook and its associated risks based on incoming financial and economic data, the dynamics of underlying inflation, and the strength of monetary policy transmission. The medium-term component of the inflation outlook occupies a central position in setting policy. Because multiple shocks impact the economy across different time horizons, a primary diagnostic task for policymakers is to isolate this medium-term inflation component through an integrated assessment of all relevant factors.
This data-dependent formulation process avoids reliance on a single-cause narrative or strict dependence on isolated data points. While energy supply shocks currently serve as the main driver of inflation, the medium-term outlook incorporates multiple considerations, including the magnitude and expected duration of the energy shock, the scale and persistence of pass-through from energy inflation to non-energy inflation, and various fiscal, artificial intelligence, and financial conditions that influence both transmission and direct medium-term outcomes. Regarding risk assessment, the monetary policy statement contains a detailed section outlining upside and downside risks to inflation and economic activity, with macroeconomic impacts rigorously modelled by Eurosystem staff.
The central bank periodically publishes scenarios mapping out potential responses to specific risk events, such as alternative paths for energy supply shocks. These published scenarios incorporate ancillary assumptions regarding the speed and intensity of pass-through to non-energy prices, alongside effects on financial conditions and activity levels, which are continuously evaluated against accumulating empirical evidence. The second key criterion, underlying inflation, becomes increasingly valuable as time elapses following an energy shock, particularly given the wide error bands surrounding medium-term forecasts during periods of heightened uncertainty. Rather than relying on a single indicator, the European Central Bank maintains a diverse battery of underlying inflation measures to capture the context-specific and covariate-dependent nature of price pass-through.
The third criterion focuses on the strength of monetary transmission, where broader financial conditions play a dual role. Beyond the direct impact of policy rates, tighter financial conditions reduce activity levels and inflation while determining the overall transmission strength for a given policy stance. To track these dynamics, the institution monitors measures such as the Macro-Finance Financial Conditions Index and the ECB-BIG index, which assesses intermediation conditions across banking and non-bank sectors.
Recent economic developments highlight the impact of these factors, with September inflation data showing headline inflation at 3.8 per cent, comprising 18.8 per cent energy inflation and 2.3 per cent non-energy inflation. As a pre-shock benchmark, headline inflation stood at 2.1 per cent in the fourth quarter of 2025, with negative energy inflation at -1.1 per cent and non-energy inflation at 2.4 per cent. Within the non-energy category, food inflation decreased from 2.5 per cent in the final quarter of 2025 to 1.4 per cent in September 2026, while core inflation edged upward from 2.4 per cent to 2.5 per cent. Inside the core basket, non-energy goods inflation rose from 0.5 per cent to 1.1 per cent, whereas services inflation eased from 3.4 per cent to 3.2 per cent.
These figures demonstrate that the energy supply shock has driven the rise in inflation over the year. Although aggregate non-energy inflation has remained contained, underlying indicators show that an upward shift in medium-term inflation has not taken hold, indicating that the rapid-adjustment mechanisms observed in 2022 have not been activated during the current shock. Nevertheless, September projections anticipate non-energy inflation to increase from 2.3 per cent in 2026 to an average of 2.6 per cent in 2027, before declining to 2.3 per cent in 2028. This projected increase stems primarily from the lagged pass-through of energy price levels, alongside marginal contributions from upgraded economic activity baselines and shifts in administered prices and indirect taxes across certain jurisdictions. Temporary weather-related increases in food prices also contribute to the anticipated peak in inflation during 2027.
