© Reuters. Fed policy shift increases heat on ECB
(Bloomberg) – The European Central Bank is likely one step closer to targeting periods of inflation above its target now that the US Federal Reserve has adopted this strategy, according to economists and the former vice president.
The Fed’s new approach, unveiled by President Jerome Powell on Thursday, is to seek inflation, which averages 2% over time. This would allow it to tolerate a faster pace after periods of weakness and avoid early rate hikes when inflation rises close to target.
President Christine Lagarde could find it a tempting option as she resumes an ECB strategy choice delayed by the pandemic. It would allow her to keep monetary policy looser for a longer period of time and worry less about the hardy ones who tend to talk about reining in stimulus, even in the rare cases that inflation has reached the current target of ” below, but close to, 2%. “
“I can not help but believe that the Fed has set the tone across major central banks,” said Piet Christiansen, chief strategist at Danske Bank. “I am confident that the ECB will weigh the pros and cons of this measure.”
Low inflation has been a long-standing concern for major central banks. The concern is that it is turning into deflation – a downward spiral of prices and wages that have historically devastated economies – during a shock, such as the current pandemic. They have responded by pumping trillions of dollars worth into the financial system with only limited success.
Former ECB Vice President Vitor Constancio is among those who say his former employer would benefit from the so-called average inflation targeting, especially because price stability is its primary mandate. In contrast, the Fed has previously pointed to full employment as proof that it has at least part of its dual mandate.
The ECB will soon have the chance to take such a step. It is conducting its first strategic review since 2003, which is expected to be completed in the second half of next year. The Fed conducted a similar evaluation before deciding on its most recent change.
Lagarde’s comprehensive assessment includes climate change and digitalisation, but the reasons for low inflation – globalization, aging populations and weak productivity – are at the core.
The key question is whether the current goal in itself is part of the problem of encouraging early policy tightening.
It may turn out to be a thorny topic. Officials such as Bundesbank president Jens Weidmann, who has often opposed looser ECB policies, and Austrian governor Robert Holzmann, who has proposed a lower inflation target, could possibly be persuaded into any shift that allows price gains above 2%.
Bank of France Governor Francois Villeroy de Galhau, who has previously approved a look at average inflation targeting, declined to speculate much as he spoke at an event hours after Powell’s announcement.
“I do not want to predict the outcome, but you can be assured that a credible and symmetrical inflation target will remain at the heart of our action,” he said.
A change can also be a hard sell sold publicly. Years of extraordinary monetary stimulus have provoked criticism, with politicians in some countries regularly paralyzing the ECB for the impact on savers. Its deposit rate has been below zero for six years.
“The Fed says this is different from the ECB, which says so because the Fed had actually raised interest rates several times,” said Rishi Mishra, an analyst at Futures First. “So they can say ‘hey, we may have been too hawkish last time. This time we waited longer. ‘What would the ECB say? ‘Hey, we’ve been waiting forever and would keep waiting forever?’ ”
Economists and strategists including Carsten Brzeski at ING Group (AS 🙂 NV and Frederik Ducrozet at Pictet & Cie believe that the ECB will change its target, but that it will not follow the Fed completely, partly due to skepticism in the Governing Council.
More likely, it will settle with a so-called “symmetrical” target of 2% with flexibility, they say. In practice, this means that it will tighten policy when inflation is above this interest rate, and loosen when it is below but not rush too fast to do so.
“There will be no majority in the Governing Council to simply copy the Fed’s move,” Brzeski said. “In the euro area, the concept of average inflation targeting has been more controversial.”