ECB's Lagarde promises not to overreact inflation surge

© Reuters. FILE PHOTO: The European Central Bank (ECB) logo in Frankfurt, Germany, January 23, 2020. REUTERS/Ralph Orlowski/File Photo

FRANKFURT (Reuters) -European Central Bank President Christine Lagarde played down inflation fears on Tuesday, and promised patience before policy tightening as the bank was determined not to overreact to what it still deems a temporary surge in prices.

With inflationary pressures steadily building on a slew of factors, from higher energy prices to supply bottlenecks, euro zone borrowing costs have risen in recent weeks as investors are bringing forward their interest rate hike expectations.

"The key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium term," she told an ECB conference.

"We will only react to improvements in headline inflation that we are confident are durable and reflected in underlying inflation dynamics," Lagarde told the ECB Forum on Central Banking. "We see no signs that this increase in inflation is becoming broad-based across the economy."

Overnight index swaps price in a 10 basis point rate hike three years from now, compared with five or six years down the line as recently as late August.

Inflation could rise as high as 4% by the end of this year, twice the rate of its target, but Lagarde argued that price growth would then quickly sink back below the bank's target and languish under the ECB's 2% objective for years to come.

"The fact that inflation can move moderately above target for a transitory period allows us to be patient about tightening policy until we are certain that such improvement is sustained," she said. "We still need an accommodative monetary policy stance to exit the pandemic safely and bring inflation sustainably back to 2%."

Adding to her case for patience, wage growth remains muted and unemployment is not expected to fall below its pre-crisis level until the second quarter of 2023.

A big policy move is still expected in December, when the bank is likely to decide to end a 1.85 trillion euro pandemic emergency stimulus scheme. The big question then will be whether more standard measures will be ramped up to pick up the slack.