Central bankers convey bad news in a certain way. They don’t mention negative things. “Between baseline and adverse,” they say.They don’t mention anything worse than we anticipated. As they put it, “the situation has evolved.” On April 14, while attending the IMF’s spring meetings in Washington, Christine Lagarde gave just that kind of carefully calibrated warning in an interview with Bloomberg Television that turned out differently than the words on the paper predicted. The president of the European Central Bank had released three scenarios last month regarding the potential effects of the Iran war on the eurozone economy. She acknowledged on TV six weeks later that the real data was no longer following the baseline. Frankfurt was keeping an eye on the economy, which had strayed into the area between the baseline and the unfavorable.
It’s important to consider what such situations actually entail because the press release’s wording softens the situation more than the underlying math. According to the baseline forecast, which was released in March, inflation in the eurozone is expected to average 2.6% in 2026 before returning to goal by 2027. The unfavorable scenario raises inflation to about 3.5% for the year and predicts more rapid increases in energy prices, with oil lingering around $119 per barrel and gas around €87 per megawatt-hour in the second quarter. In the worst case scenario, inflation would soar above 6% in early 2027 and the eurozone economy would enter a technical recession by summer, necessitating a prolonged closure of the Strait of Hormuz and substantial damage to Gulf energy infrastructure. In essence, Lagarde is stating that the current data is more in line with the second of those three images than the first.
The policy response has been remarkably muted. Throughout the March meeting and the spring report, the ECB maintained its deposit rate at 2.00%. On Bloomberg, Lagarde was specifically questioned about whether the central bank now favors tightening. No, she replied. In her words, the ECB has “a compass that indicates price stability predicated on financial stability.” That’s what central banks say when they say, “We’re watching, we’re worried, but we’re not yet convinced we need to move.” A rate increase as early as next month has been the subject of market speculation. Frankfurt is not currently confirming it.
The same week, the IMF issued a secondary downgrading, which quietly strengthened Lagarde’s position. Citing the spike in oil and gas prices that followed the Middle East crisis, the fund lowered its projected growth for the eurozone in 2026 from 1.3% to 1.1%. That seems insignificant. Two-tenths of a percentage point at this juncture in a recovery is a significant loss of momentum in terms of central banks, especially as the eurozone was already developing more slowly than the United States or the majority of emerging Asia. If it continues, a 1.1% growth year with inflation slowly returning to 2.6% is the kind of combination that starts to seem stagflationary. According to the ECB’s models, it shouldn’t. They claim that the energy shock is transient and supply-side. The question is whether business pricing policies and wages support or refute such viewpoint.
Economists have been discreetly monitoring a portion of the analysis that isn’t included in the press releases. Lagarde highlighted a subtle distinction between supply-side and demand-side shocks during her press conference, according to the ING report from the March meeting. This shows that the ECB is preparing the ground to look through the energy increase rather than react strongly. The policy reasoning is to hold rates, keep an eye on wage talks, and refrain from stifling the eurozone’s meager growth if you think the price shock is primarily imported, mostly transient, and mostly outside the central bank’s control. However, the calculus swiftly shifts if the shock begins to flow into second-round wage demands in Germany, France, and Italy or into broader inflation in services. Lagarde is on the cutting edge of analysis.
The political undertone of the IMF visit is difficult to ignore. An seemingly casual question about Lagarde’s potential resignation before her tenure ends next year was posed. Her response was purposefully memorable. “The captain stays aboard the ship when there are large clouds in the distance. Furthermore, the captain will not abandon the ship.” It’s the type of line that conveys a genuine signal in addition to being quoted because it’s intended to be quoted. Lagarde selected this time, on this stage, to officially put an end to the quiet discussion in European policy circles about whether or not she may be called for a different role—there usually is, with persons of her prominence. It’s not a coincidence.
Observing this from outside of Frankfurt, the larger image is one of an organization attempting to maintain composure in the face of increasingly difficult circumstances. Six months ago, no one at the ECB was predicting the energy shocks caused by the Iran war. European exporters are still attempting to adjust to the ways that Trump’s tariff policies are changing international trade flows. The slow-motion deindustrialization of its automotive base continues to be a problem for the German economy. The political climate in France is still precarious. For the time being, Italian debt costs are steady, but there is always drama in the news cycle. The ECB is holding rates, keeping an eye on the data, declining to commit, and waiting for clarity—which might not come at a convenient time—in opposition to all of that.
