ECB Raises The Bar For Normalisation In The Short-Run, Flexibility Is The Key For Policy

ECB bonds

Monex Europe | Today’s announcement by the European Central Bank can be perceived as net dovish in the short-term by markets, as the shift from an asymmetric target to a new symmetric 2% inflation target gives the central bank ample room to run accommodative monetary policy for longer without having to fight markets. 

Previously, the ECB’s inflation target was set at “below, but close to 2%”, which contributed to the eurozone’s structural issues with low inflation for years. By changing this target to a symmetric target, which means any undershoots and overshoots would be equally undesirable, the central bank moves the bar slightly upwards for inflation before policy is required to tighten. This shift is especially dovish in the short-term as the central bank also signalled tolerance for a temporary inflation overshoot as policy rates sit deeply in negative territory.

Over time, the ECB will include owner-occupied housing (OOH) costs in their inflation measure, which will allow them to raise inflation synthetically should the eurozone’s stubbornly low inflation rate fail to increase over the medium-term.

This will be over time, as OOH costs are now measured by EU statistics body Eurostat, however, national data will be required from eurozone countries as well in order to add them to the overall measure. Beyond this, the methodology of housing costs will need to change to fit the inflation data publishing periods. Currently, the OOH data is collected such that it is released every quarter, while inflation figures are released each month. The inclusion of OOH costs in the measure could moderately increase headline inflation, which  President Lagarde stated during the press conference. However, for operational reasons OOH are unlikely to be included in headline inflation data for some time. Its inclusion is, therefore, likely to coincide with the full economic recovery from the pandemic and when conditions are more suitable for policy normalisation. The extent to which housing is included in the inflation measure, both by weighting and composition, likely depends on the inflation trajectory over the medium-term and how achievable the path towards normalising policy is over the coming years. With flexibility over the timing and composition of the new inflation measure which includes OOH, the adaptation in the HICP measure is likely to align with the ECB’s commitment to tightening policy over the medium-term.

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