ECB set to tweak guidance to reflect its new 2% inflation target

Christine Lagarde, President of the European Central Bank (ECB), speaks during a live stream video of the central bank’s virtual press conference on the interest rate decision.

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The European Central Bank’s new inflation target and its possible impact on monetary policy will be the central topic of this week’s meeting in Frankfurt.

The hopes of the Eurozone Central Bank are high, as President Christine Lagarde repeatedly stresses the need for a vigorous monetary policy response to avoid unanchoring inflation expectations.

“We specifically recognize that the proximity to the effective lower bound requires energetic or sustained monetary policy measures,” said Lagarde during a question-and-answer session when the new strategy was presented on July 8th.

The ECB has effectively raised its inflation target in the medium term from “below, but close to 2%” to a symmetrical target of 2%, which means that both overshoots and undershoots are permissible but “undesirable”.

The US Federal Reserve also announced last year that it would let inflation run higher than normal in order to stimulate the labor market and the economic recovery. In practice, this means that the central bank is less likely to raise rates.

Since the eurozone financial crash, consumer price growth has averaged just 1.2%. In other words, despite all the extraordinary measures taken in the sovereign debt crisis, inflation has not reached the ECB’s target over the past decade.

What does this mean for monetary policy? The jury is still pending.

While some expect more than just adjustments to the ECB’s forward guidance this week, others expect real change later this year once there is more clarity about the region’s economic course and the development of the coronavirus pandemic.

“We believe last week’s comments from policymakers suggest that the ECB will go beyond changing forward guidance at its July 22nd meeting,” said Luigi Speranza, chief economist at BNP Paribas, in a recent research note .

“Our tendency is to believe that we will also get more clarity on the post-PEPP environment, which underscores the ECB’s message of continued adjustment,” he said.

Others have rather subdued expectations.

“The key message could therefore be that there is no rush to signal a tighter policy at the meetings in September / October,” said Anatoli Annenkov from Societe Generale.

“We don’t expect a better understanding of the possible end of the crisis phase of the pandemic until the end of this year, which suggests that key decisions on PEPP may not be made until then,” he added.

In March 2020, the ECB presented an emergency program to buy bonds in order to cope with the economic shock caused by the pandemic. This program, known as PEPP, is currently slated to run through March 2022 and be up to 1.85 trillion euros (2.2 trillion US dollars).

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