ECB wants higher inflation but is not adding more stimuli

Main macro themes

Number of new cases has increased in many countries amid the delta variant spreading. Importantly, the vaccines appear to be effective, as for example in the US, authorities have reported that virtually all new hospitalizations and deaths are among the unvaccinated people. With most of the elderly and risk groups fully vaccinated already, new strict lockdowns in western economies appear unlikely. Vaccine inequality remains high, though, with coverage being much weaker in most emerging economies.

ECB introduced a new strategy framework, with a symmetric 2% inflation target. ECB will aim for inflation to fluctuate around the 2% target, but the implementation will be more flexible compared to Fed’s Average Inflation Targeting (AIT), which requires inflation to overshoot the target after a period of below 2% inflation. ECB’s first meeting since the new strategy took effect was mostly about aligning the language to the review outcome. The main new element worth highlighting is the forward guidance on rates stating that inflation has to reach 'two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon' which compares 'to the end of the forecast horizon' in June. This also means that the new strategy is more focused on the duration of the accommodative policy stance and not the size of the support. For more details see ECB Research: Stepping up on inflation ambitions, but not on tools.

US inflation surprised to the upside in June: Both headline and core CPI rose by 0.9% m/m, with headline reaching 5.4% and core 4.5% y/y. Shortage of semiconductors is limiting new car production, which in turn has supported demand and prices for used cars and contributed to the higher CPI. Fed’s Powell took a dovish line in his recent remarks, once again calling for the inflationary pressures to remain transitory and saying that Fed will continue bond purchases in coming months. We still expect the Fed to turn more hawkish in the fall, as US labour markets continue their recovery. Globally, the narrative for more hawkish central banks continued in New Zealand, where RBNZ announced ending of their QE program already this July.

Market developments

Risk sentiment has been shaky in July with a big sell-off last Monday. S&P 500 has recovered since then, however. Long-term bond yields have also started to move slightly higher again with US10yr Treasury yields approaching 1.30% (still much below the 1.50% by the end of June). US 10yr breakeven inflation expectations have recovered slightly to 2.29%.

Broad USD strengthening continues, as EUR/USD has fallen below 1.18. EUR/SEK and EUR/NOK have moved slightly lower after a sharp increase due to the risk sell-off.

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