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The last time the European Central Bank raised interest rates was the same as the eurozone debt crisis started in 2011 – A move that its officials now recognize was a major mistake.
His first new strategy for almost two decades, presented on Thursday, it is designed to avoid the risk of such a premature tightening of policy in the future. It changes the Frankfurt-based institution to a 2% inflation target and is committed to tolerating any slight overshoot.
“We have learned from history and observed what has worked and what has not worked,” Christine Lagarde, President of the ECB, said while presenting the results of the review. “Now we have to show that we want to say what we say.”
The ECB has failed to persistently raise inflation to its previous target of “below but close to .2%” for much of the past decade. Analysts said the new strategy would make it easier to keep interest rates at historically low levels for longer to achieve its legal price stability mandate.
Annalisa Piazza, an analyst at MFS Investment Management, said: “Lagarde leaves the door open to strong new actions.”
Carsten Brzeski, ING’s head of macro research, said that “it clearly marks a gradual trend towards more, albeit subtle.
By abandoning its previous inflation target, the ECB seeks to banish what Lagarde called “ill-founded speculation” that would have preferred inflation to be below its target rather than above it.
Although Lagarde said his new target was symmetrical, meaning that he “considers negative and positive deviations from inflation from the target to be equally undesirable,” he added that he would be less concerned about inflation by about the goal in certain circumstances.
He said the ECB would use “particularly strong or persistent monetary policy action” when interest rates approach the lower limit and inflation remains below its target, as they have been for several years. The change “may also involve a transitional period in which inflation is moderately above target.”
This is not to say that it is actively trying to push inflation above its target, as the U.S. Federal Reserve has changed its strategy to offset a period of low inflation. Lagarde said the ECB’s new strategy was not “almost” the same as that the Fed’s average inflation policy.
This leaves the Fed in a more accommodating stance than the ECB. Still, inflation is higher in the U.S. and the Fed is expected to start tightening its policy sooner. The ECB’s new strategy makes it more likely to keep rates lower for longer, which is likely to bring the euro down against the US dollar and keep eurozone bond yields low.
“Historically, the divergence of monetary policy between major central banks has led to increased currency volatility and the appreciation of the currency that is tightening policy,” said Citigroup strategists, who predicted that the l the euro could fall from 1.18 euros to 1.16 euros against the dollar.
The biggest question left by the ECB’s announcement was what it would mean for its monetary policy, as the eurozone economy is recovering from the coronavirus crisis, which it excluded from its discussions.
“We made a very clear distinction between work on strategy review and regular work on monetary policy operations,” said Gabriel Makhlouf, governor of the Irish central bank and member of the ECB’s board.
“We will discuss any implications for monetary policy at our regular meeting, the next one will be in two weeks,” Makhlouf said. “Of course, the issue that dominates our current discussions is the impact of the pandemic and I hope it continues in the short term.”
Some analysts noted that the change in the ECB’s inflation target was partly offset by its promise to give more weight to the cost of owning a home in calculating official price growth. Frederik Ducrozet, strategist at Pictet Wealth Management, said this would add about 15 basis points to the overall inflation figure, which is already expected to exceed 2% this year.
Others said that in the long run the biggest impact of the ECB’s new strategy would come from measures aimed at climate change, although many will not come into force until 2024.
The central bank said it would develop new models of financial impact, test the stress of its own exposure to global warming, require better disclosure of companies’ climate risks and adjust purchasing policies. corporate assets and guarantees to take into account the carbon emissions of security issuers.
“Where the review is innovative, there are the aspects of climate change,” said Paul Diggle, chief economist at Aberdeen Standard Investments. “Other central banks will be reading this and thinking a lot about how they can demonstrate a similar commitment to green monetary policy.”
When the ECB board met this week, most of its 25 members, including Lagarde, broke away from discussions to see how Italy played Spain in the semi-finals of the European Football Championship.
Given how divided the board was when Lagarde took over from Mario Draghi in late 2019, there were fears that his decision to launch a strategy review fueled tensions. Instead, the unanimous agreement on the new strategy months ahead of schedule is a success for its self-taught tactics. team building, aided by collegiate meetings like this week’s.
But the real test of board unity is likely to come when it decides how to implement the new strategy, e.g. how quickly to finish its emergency bond purchase program of 1.85 million euros.
“The framework only buys little from the ECB,” said Krishna Guha, vice president of Evercore ISI. “It will gain credibility only through the determined deployment of instruments to advance the stated goals.”
Additional report by Eva Szalay in London
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