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Fed History Suggests ECB Won’t Boost Inflation on Guidance Alone

Published 07/27/2021, 01:48 PM
© Reuters.

(Bloomberg) -- European Central Bank policy makers have acknowledged that their new push to boost inflation expectations could take quite a while to kick in, according to officials familiar with the discussions.

In its strategy review this month, when it raised its inflation goal and acknowledged that it might overshoot, the ECB’s Governing Council discussed the experience of the U.S. Federal Reserve, the officials said.

U.S. expectations -- a critical signal of future price gains -- were slow to move last August when the Fed adopted average inflation targeting and said it was willing to overshoot its 2% target. They only started to gather pace months later when the incoming Biden administration started to discuss a fiscal boost to the economy.

They accelerated again early this year when the Fed kept policy loose despite price growth jumping well above 2% on soaring demand. While expectations have eased since May as Fed officials started to broach the topic of tapering stimulus, they remain relatively robust.

Likewise, there was little impact on euro-area expectations or bets on interest-rate hikes even after the ECB followed up on its strategy review by strengthening its commitment to keep borrowing costs low.

The Fed’s experience should help soothe any concerns at the ECB about the largely ambivalent response by investors and economists last week. Analyst reports mostly described the new language and President Christine Lagarde’s press conference as dovish but short on specifics.

“It is hard to see a meaningful impact on near-term growth and inflation dynamics from the promise to hike rates a little later,” Oliver Rakau, an economist at Oxford Economics, said in a report. “We continue to think that some near-term policy response, such as an immediate increase in quantitative easing, would have benefited the credibility of the new strategy.”

An ECB spokesperson declined to comment on the Governing Council’s deliberations.

The central bank’s strategy review saw the inflation goal lited to 2% from “below, but close to, 2%.” In the policy decision two weeks later, policy makers said interest rates will stay at present or lower levels until inflation projections are in line with the target “well ahead” of the end of the forecast horizon, a period that can stretch as much as three years into the future.

They also said inflation projections must stay in line with the goal until the end of the horizon, and be supported by “sufficiently advanced” underlying price dynamics. Germany’s Jens Weidmann and Belgium’s Pierre Wunsch objected because they saw the guidance as an overly long-term commitment.

What Bloomberg Economics Says...

“Achieving that goal remains a distant prospect and -- without additional policy support -- it sounds like little more than wishful thinking.”

-David Powell and Maeva Cousin. To read their report, click here

The boost from fiscal spending in the U.S. will resonate with Lagarde, who has repeatedly urged national governments not to withdraw pandemic support too soon. She said last week that “ambitious, targeted and coordinated fiscal policy should continue to complement monetary policy.”

While joint fiscal support is underway with the European Union’s 800 billion-euro ($944 billion) recovery fund, governments will invest those funds over several years.

EU rules on debt burdens and deficits are currently suspended, but only until the end of next year, and politicians in some countries are already starting to talk about the need to rein in borrowing.

If the U.S. is a guide, that could slow the return to price stability, and the longer it takes, the greater the chance that the credibility of the ECB’s new strategy and guidance is eroded.

Before last week’s decision, the central bank was projecting inflation will average just 1.4% in 2023. Professional forecasters reckon it’ll only be at 1.8% in 2026.

“I think the ECB will be tested in a very different manner,” said Patrick Krizan, an economist with Allianz (DE:ALVG) SE in Munich. “The Fed was tested on the upside. And the ECB will be tested on the downside.”

©2021 Bloomberg L.P.

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