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People may be losing faith in ECB's ability to fix inflation -ECB research

Friday, August 26, 2016 - 21:06
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Euro zone businesses and homeowners may be losing confidence in the European Central Bank's ability to lift inflation back to its target, ECB research showed on Friday, potentially adding to the very problems the bank is trying to fix.

[FRANKFURT] Euro zone businesses and homeowners may be losing confidence in the European Central Bank's ability to lift inflation back to its target, ECB research showed on Friday, potentially adding to the very problems the bank is trying to fix.

Their long-term inflation expectations are showing signs of drifting below the ECB's 2 percent target, or "de-anchoring", the ECB research paper said, despite the bank providing extraordinary stimulus to stave off deflation and push up prices after missing its objective for more than three years. "Monetary policy credibility is built gradually over the years, but we cannot rule out the possibility that it may deteriorate quite rapidly," the paper's authors Tomasz yziak and Maritta Paloviita said, noting that the ECB's credibility is intact for now.

Struggling with sluggish growth, high unemployment, weak demand and overcapacity, the euro zone economy has been in the doldrums since its 2007 debt crisis.

And even with ECB stimulus, prices have failed to rebound and governments have been slow in implementing meaningful measures that could prop up long-term growth prospects. "Our analysis suggests that in recent years inflation expectations in the euro area have shown some signs of de-anchoring," the researchers said in a paper produced independently of ECB policymakers and not necessarily reflecting their views.

They also said that the risk of de-anchoring may rise if the ECB needs to extend the timeframe needed to reach its target. The ECB expects to undershoot it for at least another two years.

With de-anchoring, monetary policy tools become less effective as price and wage setters no longer expect the ECB to hit its target in the long term. This could perpetuate a low inflation environment, increase the risk of deflation and make it even harder for the ECB to boost price growth.

Given that risk, ECB forecasts and inflation targets play a major role in managing inflation expectations, the paper said. "A more extensive use of forward guidance in monetary policy strategy (e.g. in the form of conditional interest rate path announcements for the next couple of years) can be potentially useful," the paper said.

REUTERS

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