ECB research review: Leaving no stone unturned

The ECB’s Strategy Review that President Lagarde initiated shortly after taking office in November 2019 is approaching its end. After being delayed due to the pandemic, Lagarde was asked on Monday this week if the conclusions could be reached by end of Summer, to which she replied ‘I hope so’. 

We expect the inflation target being clarified to be 2%, symmetric and flexible in its understanding of the medium-term orientation. We believe that an increased focus on sustainability will also be emphasized.

As we neither expect ECB will develop new instruments that will make the achievement of the inflation target more probable nor move the inflation objective closer to the current inflation rate objective, we do not see the probability of ECB meeting its inflation objective to be altered due to the strategic review.

Market reaction to the outcome of the strategic review is likely going to be rather muted. From a market perspective the key focus will be the formulation of the inflation objective and the monetary policy toolbox discussion.

Staying within the treaty

ECB GC members have several times said that Treaty changes were not in scope for thisongoing strategy review. This means that ECB will focus on its prime mandate which it is to ‘maintain price stability. However, Article 127 of the TFEU also say that without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union...’, which essentially also means that the EU’s focus on sustainability is also an element that ECB needs to take into account when conducting monetary policy. Furthermore, this also means that contrary to other central banks, the ECB mandate is quite narrow and as such does not entail an explicit employment mandate.

What we expect ECB will do

For the strategy review, ECB has identified 13 work streamsthat focus on various topics ranging from the price stability objective, inflation measurement over communication, and climate change as well as digitalization. We address key questions below:

Price stability objective: We expect a formulation of the objective to be symmetric around 2%. In recent years, ECB has faced criticism of an asymmetric understanding of its ‘below, but close to, 2%’formulation it has had since 2003, and a clarification of the objective should end such discussions. we expect also a flexible understanding on the 2% target entailing an understanding of inflation not always being target but hovering around the 2% level. This should provide the ECB with sufficient flexibility to calibrate its monetary policy to a holistic view about the euro area, still focussing on inflation, but without being ‘locked’ due to a specific rule. This may also mean that the medium-term orientation still holds. Contrary to the Fed’s FAIT regime which incorporates an explicit targeting of overshooting the 2% level, we expect ECB to use a less aggressive target to ‘accept’, and not ‘target’, inflation overshooting.  

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