ECB is set to tweak guidance to reflect its new 2% inflation target

July 23, 2021: -The European Central (ECB) Bank’s new inflation target and its possible effects on monetary policy will be the topic of the meeting this week in Frankfurt.

Hopes are high that the euro central bank of the zone will come up with a dovish surprise as President Christine Lagarde keeps stressing the need for a policy response to avoid de-anchoring inflation expectations.

“We recognize very specifically that the proximity to the effective lower bound requires forceful or persistent monetary policy action,” Lagarde said in a question-and-answer session when presenting the new strategy on July 8.

The ECB hiked its inflation target effectively from “below but close to 2%” to a symmetric 2% target about the medium term, which means that both overshooting and undershooting are allowed but “not desirable.”

The Federal Reserve in the U.S in the previous year also announced that it would allow inflation to run hotter than average to boost the labor market and economic recovery. This means that the central bank is less to increase interest rates.

Since the euro zone’s financial crash, consumer price growth has averaged at just 1.2%. In different words, despite all the extraordinary measures deployed between the sovereign debt crisis, inflation has not achieved the ECB’s target over the previous decade.

While some expected more than just tweaks in the ECB’s forward guidance this week, others desire a real sea change to come this year once there is more clarity about the economic trajectory of the region and the evolution of the Covid-19 pandemic.

“We think policymakers’ commentary over the last week suggests that the ECB will go beyond just change the forward guidance at its meeting on July 22,” said Luigi Speranza, chief global economist at BNP Paribas a recent research note.

“Our bias is to think that we will get greater clarity on the post-PEPP environment too, underscoring the message of persistent accommodation of ECB,” he said. Others have more muted expectations.

“The key message could thus be that there is no rush to signal tighter policy, even at the September/October meetings,” said Anatoli Annenkov of Societe Generale.

“We only expect a better understanding of the possible end of the crisis phase of the pandemic late this year, suggesting that the key decisions on PEPP may only come then,” he further said.

The ECB put forward a bond-buying program in an emergency in March of 2020 to deal with the economic shock from the Covid-19 pandemic. This program, known as the PEPP, is set to the previous until March 2022 and total up to 1.85 trillion euros.