The European Central Bank set a new inflation target on Thursday and claimed a role in fighting climate change after a strategy review that marks the biggest overhaul to date of Europe’s most powerful financial institution.
The central bank for the 19 countries that use the euro currency has picked up an array of roles over the years, from bank supervision to payment infrastructure, especially in the wake of the bloc’s debt crisis a decade ago.
Its first strategy review since 2003 was long overdue and ECB chief Christine Lagarde made it a key priority when she took over from Mario Draghi in late 2019. The project had been scheduled to take a year but was stretched to 18 months as policymakers focused on responding to the COVID-19 pandemic.
In a decision flagged by policymakers, the ECB set its inflation target at 2% in the medium term, ditching a previous formulation for “below but close to 2%,” which had created the impression it worried more about price growth above the target than below it.
But after nearly a decade of undershooting that objective, the key issue for investors was whether the ECB would be willing let inflation overshoot its target in the future or if it would follow its U.S. counterpart in targeting average inflation over a longer period to “make up” for lost price growth.
Settling what had been one of the most contentious issues among policymakers, the ECB said that inflation above and below its target were both undesirable and it would not aim to overshoot after a longer period of low inflation.
“This target is symmetric, meaning negative and positive deviations of inflation from the target are equally undesirable,” the ECB added.
But the bank conceded that in certain situations, when especially forceful or persistent monetary support is needed, inflation could moderately exceed its target for a transitory period.
Its new policy stopped short of committing to an inflation overshoot after longer periods of low price growth, however, a possible disappointment for investors who were looking for such a pledge, which would ensure stimulus well into the recovery.
A commitment to letting inflation temporarily overshoot its target was nevertheless seen bolstering the ECB’s credibility with markets that its target is indeed symmetric and policymakers do not perceive 2% as a cap, a difficulty the bank had faced with its previous target.
But it is a politically risky move, particularly among inflation-fearing Germans, and Bundesbank chief Jens Weidmann opposed such a shift until the very end.
The ECB also said it was unhappy with the current measure of inflation as it omitted large chunks of housing costs, so policymakers will also look at other measures of inflation.
“The Governing Council in its monetary policy assessments will take into account inflation measures that include initial estimates of the cost of owner-occupied housing to supplement its set of broader inflation measures,” it said.
In perhaps the biggest change, the ECB said it will do more to help the fight against climate change and will include climate change considerations in monetary policy operations in the areas of disclosure, risk assessment, collateral framework and corporate sector asset purchases.
Following are highlights of ECB President Christine Lagarde’s comments at a news conference
2%, BUT DEVIATIONS OK
“We know that 2% is not going to be constantly on target, there might be some moderate, temporary deviation in either direction of that 2%. And that is OK. What we are very concerned about is any sustainable, durable, significant deviation from the target.”
A CLEARER, SIMPLER TARGET
“We believe that this 2% is clearer, simpler to communicate, solid and with balance. Added to which, it gives us parity with a lot of other central banks around the world which are also operating at 2%, which is the generally accepted definition of price stability.”
NO DELAY WHEN RATE HIKES NEEDED
“I don’t think by having this simple and solid 2% … we’re actually pushing out the potential tightening that will take place.”
AND NO DELAY ON POLICY ANNOUNCEMENTS
“You know, when something is ready, let’s be out with it. Otherwise you have the risk of a leak here and there, and before you know it you don’t control the process anymore…. And you know everybody complains that Europe is always later. Well, the ECB is early. Good!”
RATES FIRST, TOOLS NEXT
“The key – and first and foremost – instruments that we will use are the ECB interest rates. But we also acknowledge that in circumstances such as the one we are operating in now the other tools that we have used successfully over the last 10 years are necessary tools to respond to the possible adverse shock that we are facing.
“All tools – by that we mean forward guidance, the asset purchase programmes, the TLTRO and the negative rates – are necessary tools that will remain in the toolbox that we will be able to use if needed.”
NOT YOUR ‘AVERAGE’ INFLATION TARGETING
“Are we doing average inflation targeting like the Fed? The answer is no, very squarely, because there are multiple ways to respond to this lower-bound constraint – and ours is the one I have described.”
HOUSE OWNERS’ COSTS
“What was decided by the GC (Governing Council) was to account for the consumer cost of the owners-occupied house. It has nothing to do with the investment cost that the owner incurs. It has to do with consumer cost that the owner actually incurs. It’s that particular portion that we want to take into account in order to respond to the frustrations of the many Europeans that we have spoken to that the cost of housing was not properly accounted for in our inflation measurements as they saw it.
“If you look historically over the course of time you’ll find that it’s not a very significant variation from the inflation as measured by the HICP. It varies over time … There are periods of time when those consumer costs are higher and others when they are low. On average it’s a minimal uptick from the HICP.”
CLIMATE CHANGE
“Climate change is the major challenge that the world is facing. We are not the primary actors, we are not driving the bus if you will, but we are on that bus and we have to look at whether or not, under our mandate, it has an impact on price stability.”
Photo: A view of a sign in front of the building of the European Central Bank (ECB) in Frankfurt am Main, Germany. EPA-EFE/RONALD WITTEK
