ECB Joins The Doves

#OPINIONLEADER#

 JUL 28, 2021

With the recent economic rebound in some of the major economies, we are starting to see central banks carrying out limelight-worthy actions. The Canadian and Australian central banks have both tapered quantitative easing (QE) while the New Zealand central bank has stopped the Large Scale Asset Purchase programme of its QE altogether. Even the central bank that the market pays most attention to, the Federal Reserve, has started discussions on QE tapering.

No discussions on QE tapering during meeting.

Similar to the other major economies, the European economy has also been recovering with business activities expanding at a fast pace especially in countries like Germany and France that contribute a large portion to the eurozone economy. However, no discussions on QE tapering took place during the monetary policy meeting last Thursday as attention was shifted to the recent revision of monetary policy strategy.

New inflation target.

Earlier this month, the ECB carried out its policy review that was postponed from last year due to the COVID-19 pandemic. The central bank concluded the policy review with the adoption of a symmetric 2% inflation target over the medium term. The symmetric target implies that negative and positive deviations of inflation from the target are equally undesirable. This revision of inflation target from the previous “below, but close to, 2% over the medium term” leads to more clarity and less ambiguity in terms of the ECB’s target, avoiding calls for tighter policy too soon.

Forward guidance, the only insightful takeaway from this meeting.

The key sentence of the revised forward guidance is undoubtedly “the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon”. Now that the ECB has made it clear it will only consider an interest rate hike when inflation is close to its target for a sustained period of time, it is unlikely that we will be seeing a rate hike at least through 2023.

Based on the recent economic projection material released by the central bank in June, inflation expectations for 2021, 2022 and 2023 are 1.9%, 1.5% and 1.4% respectively. The decline in inflation expectation shows a negative deviation from the ECB’s 2% target. The central bank’s President Christine Lagarde also highlighted this deviation during the press conference. She also mentioned that the recent rise in inflation in the eurozone is largely due to temporary drivers such as higher energy prices and base effects from the strong decline in oil prices. Remember that prior to the pandemic, the last time the eurozone inflation ever come close to 2% was back in December 2018. Since then, inflation has been on a downtrend, even going into the negative realm. With the challenge of achieving a sustained inflation of 2%, talks about rate hike is likely going to be off the table for the time being.

Another key point to take note in the forward guidance is that although the ECB’s 2% inflation target is symmetric, a slight positive deviation from its target is still acceptable as the central bank is expecting “a transitory period in which inflation is moderately above target”.

ECB not joining the tapering group yet.

The lack of QE tapering talks and the more accommodative approach towards monetary policy have placed the ECB under the list of dovish central banks. Furthermore, the COVID Delta variant is adding more uncertainty to the eurozone’s economic recovery. Hence, moving forward, it will not come as a surprise that the central bank decides to delay any QE tapering.