ECB sets new inflation target, climate role in strategy update

A man walks towards the European Central Bank (ECB) headquarters in Frankfurt July 25, 2019. — Reuters pic
A man walks towards the European Central Bank (ECB) headquarters in Frankfurt July 25, 2019. — Reuters pic

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FRANKFURT, July 8 — The European Central Bank set a new inflation target today and claimed a role in fighting climate change after a strategy review that marks the biggest overhaul to date of Europe’s most powerful financial institution.

The central bank for the 19 countries that use the euro currency has picked up an array of roles over the years, from bank supervision to payment infrastructure, especially in the wake of the bloc’s debt crisis a decade ago.

Its first strategy review since 2003 was long overdue and ECB chief Christine Lagarde made it a key priority when she took over from Mario Draghi in late 2019. The project had been scheduled to take a year but was stretched to 18 months as policymakers focused on responding to the Covid-19 pandemic.

In a decision flagged by policymakers, the ECB set its inflation target at 2 per cent in the medium term, ditching a previous formulation for “below but close to 2 per cent,” which had created the impression it worried more about price growth above the target than below it.

But after nearly a decade of undershooting that objective, the key issue for investors was whether the ECB would be willing let inflation overshoot its target in the future or if it would follow its US counterpart in targeting average inflation over a longer period to “make up” for lost price growth.

Settling what had been one of the most contentious issues among policymakers, the ECB said that inflation above and below its target were both undesirable and it would not aim to overshoot after a longer period of low inflation.

“This target is symmetric, meaning negative and positive deviations of inflation from the target are equally undesirable,” the ECB added.

But the bank conceded that in certain situations, when especially forceful or persistent monetary support is needed, inflation could moderately exceed its target for a transitory period.

Its new policy stopped short of committing to an inflation overshoot after longer periods of low price growth, however, a possible disappointment for investors who were looking for such a pledge, which would ensure stimulus well into the recovery.

A commitment to letting inflation temporarily overshoot its target was nevertheless seen bolstering the ECB’s credibility with markets that its target is indeed symmetric and policymakers do not perceive 2 per cent as a cap, a difficulty the bank had faced with its previous target.

But it is a politically risky move, particularly among inflation-fearing Germans, and Bundesbank chief Jens Weidmann opposed such a shift until the very end.

The ECB also said it was unhappy with the current measure of inflation as it omitted large chunks of housing costs, so policymakers will also look at other measures of inflation.

“The Governing Council in its monetary policy assessments will take into account inflation measures that include initial estimates of the cost of owner-occupied housing to supplement its set of broader inflation measures,” it said.

In perhaps the biggest change, the ECB said it will do more to help the fight against climate change and will include climate change considerations in monetary policy operations in the areas of disclosure, risk assessment, collateral framework and corporate sector asset purchases. — Reuters

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