In a surprisingly early conclusion of its monetary policy strategy review, the European Central Bank (ECB) rolled out several changes that will likely keep monetary policy easier for longer.
The good news: The ECB adopted an easy-to-understand, symmetric (i.e., negative and positive deviations of inflation are equally undesirable) 2% inflation target. The not so good news: The ECB did little to explain how it will achieve 2% inflation, other than committing to “especially forceful or persistent monetary policy measures to avoid negative deviations from the inflation target.” This creates a credibility issue that we think will leave inflation expectations subdued.
To its credit, the ECB has achieved price stability, albeit at lower rates in recent years. Today, the Harmonised Index of Consumer Prices (HICP) sits at a level equivalent to a 1.7% inflation. The ECB now wants to achieve 2%. The difference between 1.7% and 2% might sound like splitting hairs to some, but for monetary policy that primarily uses the blunt tool of interest rates to affect consumer prices, the difference is big. To begin with, the 1.7% average inflation realised so far encompasses two halves: While inflation averaged 2% during the decade following the euro’s founding in 1999,
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