ECB: New Language, Same Policy Stance
- By Caroline Grady
- 2 min read
The ECB’s first meeting post strategy review produced no policy surprises. The central bank adjusted forward guidance on interest rates to fit the new target and that, as expected, means rates lower for even longer. APP remains tied to the rates outlook and may therefore continue longer than under the old target. But despite a commitment to clearer policy communication and the new higher inflation target, the overall policy stance changed little.
Revised forward guidance comes via the following lengthy sentence:
‘In support of its symmetric two per cent inflation target and in line with its monetary policy strategy, the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at two per cent over the medium term.’
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Summary
- The ECB announced updated forward guidance on interest rates to incorporate its new symmetric 2% inflation target.
- Lagarde describes the changes as a commitment to patience and avoidance of any premature policy tightening.
- Despite the new language, little has changed in terms of the ECB’s ability to reach 2%.
- September’s forecast update will be the first test of what the new inflation target means for policy.
The ECB’s first meeting post strategy review produced no policy surprises. The central bank adjusted forward guidance on interest rates to fit the new target and that, as expected, means rates lower for even longer. APP remains tied to the rates outlook and may therefore continue longer than under the old target. But despite a commitment to clearer policy communication and the new higher inflation target, the overall policy stance changed little.
Revised forward guidance comes via the following lengthy sentence:
‘In support of its symmetric two per cent inflation target and in line with its monetary policy strategy, the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at two per cent over the medium term.’
President Christine Lagarde split this into three key components: 1) well ahead, 2) durability and 3) realized progress. The ‘well ahead’ component depends on both staff forecasts and the view of the Governing Council and is somewhere around the midpoint of their three-year forecasts. Meanwhile, the ‘durability’ reference reflects a commitment to patience and the ‘realized progress’ on core inflation needed to ensure that the trajectory is consistent with achieving the new inflation target.
But rather than a ‘lower for longer’ narrative, Lagarde said the new forward guidance should be interpreted as an avoidance of ‘premature tightening’. This was also why the Governing Council statement included the comment from the strategy review that ‘this may also imply a transitory period in which inflation is moderately above target’.
As for the APP and PEPP, nothing changed on this front. The stepped-up pace of PEPP purchases will be reviewed in September and once again depend on an assessment of 1) financing conditions and 2) the outlook for inflation. So for now, the recent pace of around €21bn per week is set to continue, and the language around purchases continuing until at least end-March 2022 or until the coronavirus crisis is deemed over remained unchanged. The current stock stands at almost €1,230bn versus the total envelope of €1,850bn. How exactly the ECB will determine the crisis is over remains unclear, although vaccine rollout is a key component.
Overall, despite the updated forward guidance on interest rates and the language stressing commitment to reach the new 2% symmetric target, the ECB hinted at no new stimulus to get there. It mentioned the Delta variant as a downside risk to the forecasts, although it still deemed risks to growth as balanced overall, particularly with the June forecast already incorporating assumptions on some restrictions remaining in place. And the medium-term inflation outlook remains subdued with weak wage growth and past euro appreciation. September’s forecast update could be the first test of what the new inflation target means for policy.