ECB Strategy Change Analysis: Lagarde lags behind dovish Fed, EUR/USD has room to rise

A German loss? The European Central Bank has removed the 2% ceiling from its inflation target, allowing price rises to temporarily and moderately overshoot. The Frankfurt-based institution has finally unchained itself from the Bundesbank's legacy of total intolerance to somewhat higher inflation. 

If the ECB has loosened its concerns about price rises, a dovish move that would imply lower interest rates for longer, and thus a weaker euro. However, the euro stands out with gains. How come? The easy explanation is that this shift was priced in for a long time. The "below, but close to 2%" goal was anachronistic and doomed to the dustbin of history. 

However, there are additional ways to look at the bank's strategic change – and especially what it lacked. Most importantly, the ECB is sticking to using headline inflation – including volatile energy and food – as its gauge, not core prices like the Federal Reserve. While President Christine Lagarde is unlikely to raise rates in response to a leap in oil prices – as former President Jean-Claude Trichet did – her ECB is unlikely to push for bold Fed-like moves.

Lagarde added her own comparison to the Fed. When asked if the ECB would adopt her American peers' average inflation targeting – allowing price rises to compensate for past weakness – her answer was a categorical no. That means the Fed is more dovish than the ECB, favoring EUR/USD longs. 

Another minor factor supporting the common currency comes from the bank's consideration of using the costs of owner-occupied homes into its inflation gauge. As prices are rising faster in that sector, that would push overall inflation higher, thus making monetary policy more accommodative. The Fed disregards house prices. 

Overall, Lagarde's dovish shift was not only priced by markets, but also marginal – perhaps less than the bare minimum. It is hard to blame the leader alone – perhaps German members and other hawks also restrained the ECB from taking bolder steps. 

Nevertheless, she is at the front, and to quote her directly from her press conference: 

I don't think that by having this simple and solid 2% target, we are pushing out the actual tightening that would take place, no

Lagarde basically said the move is not dovish.