Jeremy Sterngold, Head of Fixed Income
Two weeks ago, at the Jackson Hole Symposium, the US Federal Reserve (Fed) announced that it would change the way it conducts monetary policy. More specifically, they will now seek to maintain an 'average' inflation target which allows inflation to run above target for some time, before the Fed considers tightening policy. The outcome of this revised approach should keep interest rates lower for an even longer period of time.
At the start of the year, under the leadership of Christine Lagarde, the European Central Bank (ECB) announced that it would conduct a review of its monetary policy strategy at the end of the year. Due to the pandemic however, this has now been delayed to the middle of next year. The review will consider its price stability target, monetary policy toolkit, as well as other monetary and economic analyses. Whilst the Fed has a mandate to target inflation, maximum employment and moderate long-term interest rates, the ECB's mandate is solely to target price stability, with an inflation target of below but close to 2%.
Looking back over the past 15 years, the ECB has found meeting its mandate rather difficult. While there have been temporary overshoots of its target, this was mostly due to strong oil prices following the financial crisis. Core inflationary pressures have barely been above 1.5% over the past decade, and more recently this has hovered closer to 1%. These persistently low levels of price pressures come despite extraordinary levels of monetary stimulus, such as negative interest rates, cheap loan facilities as well as purchases of sovereign and corporate bonds. If the ECB continues to not reach its mandate, it could cause a decline in its credibility, and in turn reduce the efficacy of its stimulus measures and ability to reassure markets.
Although the pandemic has brought about even larger amounts of stimulus from all central banks, and put inflation targeting on the backburner relative to maintaining financial stability, this matter will rear its head again when life reaches a degree of normality. As a result of this, we could well see the ECB following the Fed in adopting a more flexible inflation target. However, given that actual inflation has persistently undershot its target, this would mark a less significant change relative to its US counterpart. Adopting an employment target might be more beneficial given the historically higher levels of unemployment in the Eurozone as a whole, compared to the US and the UK.
It seems evident that the ECB needs to alter its mandate to regain more credibility and potentially make its tools more effective for subsequent economic crises. Whilst we personally believe an employment target is a more desirable option, the political nature of the organisation and the differing economic prospects of individual Eurozone nations may make a large scale change difficult. As President Lagarde noted this week at their press conference when asked about the Fed's shift, "it would be totally unwise, and not loyal at all, for me to already prejudge what the strategy review deliberation will be". The Fed may have given more impetus for the ECB to adopt meaningful changes, but given the delicate political considerations, we also find it difficult to prejudge what actions will be taken.
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