ECB policy: easy for longer
Following the release of its strategy review on July 8, the focus of today’s European Central Bank Governing Council (GC) meeting was how to put this new strategy into words . As widely expected, the ECB revised its forward guidance on interest rates (see press release) to reflect its new strategy.
The main change today was the shift in the ECB’s forward guidance from a projection-based to a (partially) outcome-based framework. But this is no revolution. Under Mario Draghi’s presidency, the ECB was already increasingly focused on underlying inflation dynamics, effectively shifting to a symmetric inflation target. To a large extent, today’s policy statement therefore is a formalisation of existing policy. However, a formal ECB commitment to its new strategy may make it harder for the hawks to challenge it in the future, including in the event of a temporary inflation overshoot.
Importantly, the ECB’s new forward guidance is consistent with an even later hike in interest rates than under its previous framework—but it does not fundamentally change the criteria that will trigger policy normalisation.
The GC confirms that it will needs to see headline inflation reaching 2% “well ahead of the end of its projected horizon and durably for the rest of the projection horizon”, but also “realised progress in underlying inflation” consistent with its inflation target over the medium term. The reference to actual core inflation data is important because it suggests the ECB will not tighten its stance if staff projections are above 2% but measures of underlying inflation are not moving in the same direction. But again, it is hardly new policy as the ECB has been focusing on realised core inflation dynamics for a long time already. Overall, under current staff projections, which foresee headline inflation at 1.4% and core inflation at 1.3% by 2023, there is little doubt that the ECB will not hike rates before 2024.
Today’s recalibration of its guidance was not unanimous. We expect more disagreement to come when the ECB starts discussing adjustments to its bond-buying programmes (the Pandemic Emergency Purchase Programme (PEPP) and the Asset Purchase Programme (APP)).
Our long-held view remains unchanged. We continue to believe that the APP will be increased in size and made more flexible, with operational changes ranging from the eligibility of Greek bonds to the share of supranational debt securities, capital keys, etc. At this stage, it is unclear whether the GC will stick to its open-ended commitment to buy a fixed amount of debt securities each month until its new strategic objectives are met, or whether it will move to a flexible purchase envelope, for instance. The just-completed strategic review commits the ECB to gradually include climate-change risk in its policy framework over the coming years. In addition, the longer quantitative easing goes on under the proposed new strategy, the higher the chances that issuer limits will have to be revisited.
Given the complexity of all these issues and divergence within the GC, we suspect that there will have to be compromises between doves and hawks for the GC to reach an agreement on the future of its quantitative-easing strategy.