ECB to Consider Inflation Overshoot in Echo of Fed Strategy

(Bloomberg) -- European Central Bank President Christine Lagarde said it’s worth examining a Federal Reserve-style strategy that allows inflation to temporarily rise above the institution’s target.

A policy of committing to make up for low inflation after missing the goal for a while “could be examined” as part of the institution’s strategic review, Lagarde said at a conference in Frankfurt on Wednesday.

“If credible, such a strategy can strengthen the capacity of monetary policy to stabilize the economy when faced with the lower bound,” she said. “This is because the promise of inflation overshooting raises inflation expectations and therefore lowers real interest rates.”

Lagarde’s remarks are arguably the strongest signal yet that the ECB will change its goal, after falling short of the “below, but close to, 2%” aim for years despite massive monetary stimulus. While the president said she wasn’t presenting any conclusions, she noted that structural factors such as globalization are keeping inflation subdued.

She didn’t comment on the immediate outlook for monetary policy, though she said the anchoring of longer-term market-based inflation expectations might have “softened.”

The Frankfurt-based central bank started its first comprehensive review in almost two decades late last year, before it was delayed by the coronavirus pandemic. It covers a wide range of topics including the inflation goal as well as climate change and digitization.

The Fed agreed earlier this year to start targeting an average inflation rate of 2%, giving it room to overshoot to make up for earlier underperformance. That suggests it’ll probably keep U.S monetary policy looser for longer.

Bundesbank President Jens Weidmann -- speaking at the same event -- urged policy makers to be careful in making changes to the ECB’s strategy, and repeated his warnings that large-scale bond purchases could blur the line between monetary and fiscal policy.

“The more widely we interpret our mandate, the greater the risk that we will become entangled with politics and overburden ourselves with too many tasks,” he said. “As a consequence, our independence might be called into question, and rightly so.”

Bank of France Governor Francois Villeroy de Galhau said at the same event that because the ECB’s approach to its goal is “symmetric and medium-term” it can achieve similar outcomes to average inflation targeting. That’s in line with previous signals that he’s open to letting inflation rise above the target.

Finland’s Olli Rehn told his country’s parliament on Wednesday that the strategic review is needed now more than ever because of slow inflation and the damage from the coronavirus.

Falling Prices

The record recession caused by the outbreak has compounded the challenge. Germany, Europe’s biggest economy, reported the steepest decline in consumer prices in more than five years on Tuesday. Data for the euro area are due on Friday.

Lagarde has acknowledged that prices in the region will decline in coming months, but says they should turn up again in early 2021. That may not be sufficient for some policy makers, who have started to prepare the ground for more monetary stimulus.

Executive Board member Fabio Panetta has argued that the risk of delivering too much stimulus is smaller than being “too shy,” and Bank of Spain Governor Pablo Hernandez de Cos has said weak price pressures show there is “no room for complacency.”

At separate events on Wednesday, Estonia’s Madis Muller said the economic recovery will slow, while Slovakia’s Peter Kazimir said current monetary-policy settings will remain in place for quite some time. Villeroy said central banks are “by nature, never short of ammunition.”

The ECB has pledged to buy as much as 1.35 trillion euros ($1.6 trillion) in government bonds and other assets under a pandemic emergency program, and is widely expected to announce a boost by the end of the year.

The central bank’s latest projections shows inflation averaging only 1.3% in 2022. The appreciation of the euro this year is making the task more difficult by weighing on import prices.

Chief economist Philip Lane, who has previously signaled that more stimulus will be needed to return inflation to its pre-virus path, wrapped up the Frankfurt event by saying the ECB has work to do.

“Really understanding these shocks, understanding the relationship between shocks to activity and to the inflation process is so important,” he said. “The pandemic makes a big difference.”

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