ECB Unveils Policy Regime Change That Lets Inflation Overshoot
A star of the euro sign sculpture hangs illuminated near the former European Central Bank (ECB) headquarters at night in Frankfurt, Germany. (Photographer: Krisztian Bocsi/Bloomberg)

ECB Unveils Policy Regime Change That Lets Inflation Overshoot

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The European Central Bank raised its goal for inflation and may let it overshoot the target for a while, giving officials more discretion in how to bolster the economy after years of lackluster performance.

In the culmination of an 18-month review published Thursday, policy makers agreed to seek consumer-price growth of 2% over the medium-term with a “symmetric” aim.

ECB Unveils Policy Regime Change That Lets Inflation Overshoot

The ECB said that when interest rates are close to their lower limit, as now, the economy will need “especially forceful” monetary stimulus that could “imply a transitory period in which inflation is moderately above target.”

The new wording is a significant change from the previous “below, but close to, 2% over the medium term,” which some monetary officials felt was too vague and led to calls for tighter policy too soon.

“The new formulation removes any possible ambiguity and resolutely conveys that 2% is not a ceiling,” President Christine Lagarde told reporters in a press conference, adding that the strategy review was agreed unanimously. “What we want to do is to avoid the negative deviation that will entrench inflation expectations.”

What Bloomberg Economics Says...

“The outcome of the European Central Bank’s strategy review points to a more expansionary bias for monetary policy.”

- David Powell and Maeva Cousin. To read their report, click here

The outcome “can be perceived as net dovish in the short-term,” said Ima Sammani, FX Market Analyst at Monex Europe. “The new symmetric inflation target gives the central bank ample room to run accommodative monetary policy for longer without having to fight markets.”

Still, the euro gained after the announcement as traders perceived the ECB’s new strategy as less aggressive than the Federal Reserve’s flexible inflation targeting. The common currency was up 0.5% at $1.1848 at 2:42 p.m. Frankfurt time. It’s fallen from around $1.22 a month ago.

On climate change, another controversial topic for some central bankers, the institution said it will now include considerations on that matter in its monetary policy operations. Meanwhile officials also said they will start considering owner-occupied housing costs in their supplementary measures of inflation.

ECB Unveils Policy Regime Change That Lets Inflation Overshoot

The strategy review is the first by the institution since 2003, and the most comprehensive and ambitious attempt to rethink its role in serving the euro zone’s 342 million citizens since the creation of the single currency.

The ECB’s revamped mission follows a similar effort by the Fed to question its approach to the economic challenges of the 21st century after years of elusive attempts throughout the advanced world to sustainably revive consumer prices.

Lagarde sought to differentiate the new strategy from the one now pursued in the U.S., insisting that her institution isn’t doing average targeting.

The outcome of the review reflects a grand bargain among ECB policy makers that gives Lagarde a chance to draw a line on divisions on the Governing Council over how far the central bank should go in supporting the economy.

ECB’s New Strategy
  • Inflation goal changed to “symmetric” target of 2% over the medium term from “below, but close to, 2%”
  • ECB may allow transitory period in which inflation is moderately above target
  • Governing Council recommends inclusion of owner-occupied housing into inflation measure over time
  • Climate-change considerations will be included in monetary policy operations in areas of disclosure, risk assessment, collateral framework and corporate-sector asset purchases
  • New strategy will be applied starting with July 22 monetary policy meeting
  • Governing Council intends to assess its strategy periodically, with the next assessment expected in 2025

Officials from Germany in particular found that the stance of her predecessor, Mario Draghi, represented a bias toward easy money that undermined the postwar inflation-fighting steadfastness of the Bundesbank on which the ECB was modeled as a condition for the country’s participation in the euro.

Lagarde said interest rates will be the ECB’s “primary” tool but that unconventional tools such as bond-buying programs and long-term bank loans will remain the toolbox.

She also said the ECB will change its communication strategy, making her introductory statements “shorter and crisper” following monetary-policy decisions and explaining itself more to the public with events such as the “listening events” it used during the review.

Policy makers studied a wide range of economic trends and tools to understand why they’ve struggled to boost inflation despite negative interest rates and trillions of euros of monetary stimulus.

“The big question is really now, how do you follow this up?,” said Anatoli Annenkov, an economist at Societe Generale SA. “Does it mean that they’ll be more aggressive in easing, which I think is difficult? We’re looking at a more delayed reaction function as inflation raises to the target, that should imply a very dovish ECB going forward.”

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