The ECB's new(ish) strategy... are we really any the wiser?

 

ref :- "Promises, promises..." , The Economist, Finance and Economics

Mmm... things are trying (not entirely convincingly) to steady up this morning after a pretty sobering Monday. In the UK, Covid restrictions were lifted but the mood was anything but celebratory. Anecdotal evidence suggests that more people were wearing masks as they went about their business than they were before the lockdown ended. That may suggest a welcome grasp of personal responsibility not always evident in Old Blighty but one wouldn't bank on it, not once the nightclubs, sporting events etc. truly get going again. In any event, the downbeat sentiment caused by the surge in Covid cases, particularly in those of the Delta variant, was a global phenomenon. Global stocks fell by about 2%, and the real barometer of just how confident investors are feeling - the demand for the safe haven of government bonds - indicated some pretty severe concern about just how the current wave of infection might render previous growth projections... well, optimistic shall we say? On what was definitively a "risk-off day", the US 10yr Treasury yield fell 12 basis points to 1.18%, a pretty stark reflection of how buoyant spirit has been undermined if you consider that it had climbed just shy of 1.80% back in late March.

NOTE: Oil prices, themselves a good indicator of growth prospects, sunk by well over 6% yesterday. Of course a good deal of that can be ascribed to ratification of a deal amongst OPEC+ members to increase production, but the timing could hardly have been worse and it undermines just what a difficult act it will continue to be to balance the demands of its members with economic realities.

Anyway, for not particularly obvious reasons the day's action reminded us of this recent piece in the Economist, which takes a look at the ECB's new monetary policy strategy announced after lengthy review on July 8th (so not that new, then?). There are some interesting elements that will now be incorporated into ECB policy: to include climate change considerations in its models (admirable, but made even more difficult by renewed concerns about growth) , and to join most other central banks in including costs of home-owning in inflation calculations (why wouldn't you?).

But the headline news was of course the ECB's new target for inflation. You will all recall that the previous target was "below, but close to, 2%". As statements of intent go, this has always struck us as spectacularly woolly. What exactly did that mean? The obvious conclusion, and therefore the general consensus, was a range of 1.7 - 1.9%, but the lack of clarity has not been helped by the fact that actual rates of inflation have been so far below what has been presumed to be the target. Since 2013, the average rate of inflation has been just 0.9%, which in practical terms makes debate about what the target really might be fairly pointless. In fairness to the ECB, with below-zero rates and huge rafts of bond-buying they have tried to spark the Eurozone economy and prompt a little healthy inflation, but with little success.

So, in line with some other major central banks the goal will be to achieve a "symmetrical" target of 2%, from which we might conclude that the ECB will tolerate periods of above-target inflation to compensate for periods of lower price growth in order to achieve an average over time of about 2%. At least, this is the policy being followed by the US Federal Reserve and as such the announcement has, generally-speaking, been welcomed. Importantly, it soothes anxiety that if and when things do start moving to the upside the ECB won't turn the taps off too early - something they have a less-than-glorious history of doing (2008, 2011).

The trouble is, and this is specifically an ECB thing, although all 25 members of the ECB's governing council supported the new target, it already seems as though "the strategy seems to mean different things to different rate-setters", as the Economist puts it. Ah, here we go again... there have always been hawkish and dovish camps within the ECB representing the desire for conditions that best suit the needs of the individual nations they represent. On the one hand, the hawks are most keenly represented (to no one's surprise) by Jens Wiedmann of Germany's Bundesbank, who made clear his view that although the inflation rate might slip above target temporarily it would not be the ECB's aim to exceed it. On the other, doves like Olli Rehn, boss of Finland's central bank state that the ECB will be more like the US Fed, happy to tolerate periods when the rate overshoots to make up for previous underperformance. 

One could point out that there are often differences between FOMC members of the Fed, but differences at the ECB are driven by matters of national interest. They may have been driven underground for a while by the necessity for total cohesion in the response to the pandemic, but this ongoing fault line in a multi-nation body does little for the clarity that the ECB's new strategy hopes to achieve.

Which is pertinent, because on Thursday ECB president Christine Lagarde will speak after the ECB's monetary policy meeting and she will need to portray the ECB as unified in its objectives. As far as actual new measures are concerned, expectations range from none at all, to a minor and largely cosmetic tightening achieved by gradually reducing the pandemic-related bond purchasing programme whilst at the same time compensating in part by boosting pre-existing QE arrangements.

Come to think of it, that must be why yesterday's action and the realisation that the pandemic is gathering pace once more reminded us of this article in the first place. Whether one agreed with them or not, there have been legitimate reasons why some might have been considering when would be the right time to take a pull on the reins. But right now, at this precise moment, it's hard to see any central bank reducing support whether they've got a record of over-zealous and mistaken previous action or not.