- ECB president Christine Lagarde leaves the door open to tweaking the central bank’s 2% inflation target at a speech in Frankfurt.
- “In the current environment of lower inflation, the concerns we face are different and this needs to be reflected in our inflation aim,” she told the “ECB and Its Watchers XXI” conference.
- The ECB could follow in the footsteps of the Federal Reserve, which in August announced a revamp to how it manages US inflation.
- The euro eased modestly against the dollar following Lagarde’s remarks.
Christine Lagarde, the president of the European Central Bank, has suggested the bank might allow inflation to run above its current 2% target, given persistently weak consumer price growth and interest rates that are already below zero and offer little in the way of economic firepower.
At a speech to “ECB and Its Watchers XXI” conference in Frankfurt on Wednesday, Lagarde said low inflation presented fundamental challenges to any central bank.
The ECB has kept euro zone rates at zero for almost four years, partly as it has sought to shore up the economy from the long-term effects of the 2010-2012 debt crisis, and partly to bring a rise in consumer prices.
Lagarde said persistent failure on behalf of a central bank to meet its inflation target eventually feeds into long-term inflation expectations.
“Since 2003, the ECB has used a double-key formulation to set our objective, defining price stability as a year-on-year increase in inflation of “below 2%”, while aiming for inflation of “below, but close to, 2%”,” Lagarde said in her speech.
“This formulation was appropriate at a time when the ECB was seeking to establish credibility and too-high inflation was its main worry. But in the current environment of lower inflation, the concerns we face are different and this needs to be reflected in our inflation aim,” she said.
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Lagarde said in the euro area, annual inflation averaged 2.3% from 1999 to the start of the financial crisis in August 2008, but only 1.2% from then until the end of 2019.
The central bank’s preferred rate – annual core inflation, which excludes volatile prices of energy, food, alcohol and tobacco – is currently at an all-time low of 0.4%.
The last time the core rate was anywhere near 2% was in 2009 and has been below 1.5% for the better part of a decade, barring the occasional rise above this level.
Europe was at the epicenter of the coronavirus outbreak back in March and a number of eurozone countries, including Spain, Italy and France, have recorded some of the highest death rates from Covid-19 in the world.
The eurozone economy shrank by nearly 15% in the second quarter of this year and the ECB has pumped nearly a trillion euros into the financial system. TradingEconomics estimates the annual growth rate will trend around 4% by next year and moderate to 2.3% in 2022.
Lagarde said based on the measures the central bank has taken since March this year, inflation will increase by around 0.8 percentage points cumulatively between 2020 and 2022, and GDP growth by around 1.3 percentage points.
“We have to reflect on what will happen if natural rates remain low and inflation stays subdued – meaning central banks have to continue to resort frequently to balance sheet policies to deliver on their mandates,” she said.
Goldman Sachs said in a note on Tuesday it expected “only a gradual increase, with core inflation at 1.3% by the end of 2023.”
The US Federal Reserve in August also said it would shift monetary policy to target an average rate of inflation, which would allow it to let consumer prices rise beyond 2% without having to raise interest rates.
In an environment of low inflation, prices appear to be less responsive to the real economy, Lagarde said, meaning that the central bank has fewer means at its disposal to ward off a potentially damaging spiral of disinflation, particularly when interest rates are already at rock-bottom.
“Lagarde at the ECB watchers conference opens the door to average inflation targeting (like the Fed),” ING economist Peter Vanden Houte tweeted. “This would mean that monetary policy will remain loose for even longer (because inflation has to overshoot to make up for the undershoot in the past),” he said.
The euro eased modestly in reaction to Lagarde’s comments, showing a 0.3% loss on the day against the dollar to $1.1709, off an earlier session high of $1.1755.
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