Lagarde Warns of Prolonged Inflation Shock and AI Valuation Risks

European Central Bank (ECB) president Christine Lagarde believes that the current inflation shock facing the euro area will last longer than expected. The ongoing conflict in the Middle East, particularly the Iran war, is driving up energy costs and pushing prices higher across the board.

The ECB raised interest rates for the second time since the Iran war began, taking the deposit rate to 2.5%. This move comes as inflation currently sits above 3%, prompting officials to expect further tightening may be required to bring price growth back toward the ECB's 2% target.

Bundesbank president Joachim Nagel echoed this view, suggesting that borrowing costs may need to move into mildly restrictive territory to control inflation. New ECB projections show faster inflation through 2027 and 2028, with the latter year expected to sit slightly above target.

Lagarde also expressed concern about the AI sector's valuations, describing them as 'very high' and warning that a correction is possible due to circularity risk. She noted that European banks hold AI-related assets but are stronger than in previous cycles.