ECB agrees on new inflation goal of 2%, will allow overshoot
European Central Bank policy makers have agreed to raise their inflation goal to 2% and allow room to overshoot it when needed, according to officials familiar with the matter.
The decision marks a significant change from the previous target of “below, but close to, 2%,” which some policy makers felt was too vague. The consensus emerged at a special meeting on Tuesday and Wednesday to conclude the ECB’s first strategy review in almost 20 years.
The revamped strategy could give officials the justification for sustaining ultra-loose monetary policy for longer as they strive to reverse years of below-target inflation, which have weighed on the euro area’s economic potential.
It will also be crucial for guiding the central bank’s actions as the economy recovers from the pandemic. Policy makers are expected to debate after the summer how to exit emergency measures that include an exceptionally flexible €1.85 trillion bond-buying programme.
Fiscal, monetary policies
An ECB spokesman declined to comment. The report helped push European government bonds higher across the board on Thursday morning, with the yield on Germany’s 10-year securities extending declines to a three-month low.
The official results of the review will be published at 1 pm Frankfurt time on Thursday, and President Christine Lagarde will hold a press conference 90 minutes later.
It also covers a wide range of other policy issues including how to aid the fight against climate change, the interaction of fiscal and monetary policies, employment trends and globalisation.
The inflation goal was at the core of the appraisal. Lagarde said last month that while policy makers treated it symmetrically - meaning they’re committed to respond equally to too low and too high outcomes - the current phrasing may have made their commitment “confusing for observers and for markets.”
The outcome addresses that, seeking to entrench inflation expectations consistent with the new goal among investors and the wider public.
“Certainly you would think that this should push out future potential interest-rate hikes even further, and it would also, in my opinion, necessitate more asset purchases going forward,” said Jacob Kirkegaard, a senior fellow at the German Marshall Fund.
“But of course, the reality is that even a target like that grants the ECB potentially a lot of discretion.”
The euro was little changed on the report, and was down 0.2% at $1.1798 at 9.56 pm in Frankfurt.
The ECB approach will be different to the policy of average inflation targeting that the Federal Reserve announced last year after its own review, which implies an automatic overshoot after periods of weakness.
Bundesbank President Jens Weidmann is among officials sceptical of such an approach. He has said maintaining loose policy when actual inflation is above the target over the medium term may give the impression the central bank is deliberately keeping government borrowing costs low, undermining its independence with what is known as fiscal dominance.
While inflation is already predicted to rise well above target toward the end of this year, Lagarde and her colleagues have repeatedly said they expect it to subside to below the goal in the medium term.
Executive Board member Isabel Schnabel hinted on Saturday that the ECB might allow for overshooting. In a speech in Germany, she said policy makers needed to let actual underlying inflation dynamics be seen to line up with forecasts.
“Such patience may lead to inflation outcomes being moderately above our aim for a temporary period of time,” she said. “This will be a necessary and proportionate requirement.”
©2021 Bloomberg L.P.
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