ECB to consider inflation overshoot in echo of Fed strategy

[FRANKFURT] European Central Bank President Christine Lagarde said it's worth examining a Federal Reserve-style strategy that allows inflation to temporarily rise above the institution's target.

A policy of committing to make up for low inflation after missing the goal for a while "could be examined" as part of the institution's strategic review, Ms Lagarde said at a conference in Frankfurt on Wednesday.

"If credible, such a strategy can strengthen the capacity of monetary policy to stabilise the economy when faced with the lower bound," she said. "This is because the promise of inflation overshooting raises inflation expectations and therefore lowers real interest rates." Ms Lagarde's remarks are arguably the strongest signal yet that the ECB will change its goal, after falling short of the "below, but close to, 2 per cent" aim for years despite massive monetary stimulus. While the president said she wasn't presenting any conclusions, she noted that structural factors such as globalisation are keeping inflation subdued.

She didn't comment on the immediate outlook for monetary policy, though she said the anchoring of longer-term market-based inflation expectations might have "softened." The Frankfurt-based central bank started its first comprehensive review in almost two decades late last year, before it was delayed by the coronavirus pandemic. It covers a wide range of topics including the inflation goal as well as climate change and digitisation.

The Fed agreed earlier this year to start targeting an average inflation rate of 2 per cent, giving it room to overshoot to make up for earlier underperformance. That suggests it'll probably keep US monetary policy looser for longer.

Bundesbank President Jens Weidmann - speaking at the same event - urged policy makers to be careful in making changes to the ECB's strategy, and repeated his warnings that large-scale bond purchases could blur the line between monetary and fiscal policy.

"The more widely we interpret our mandate, the greater the risk that we will become entangled with politics and overburden ourselves with too many tasks," he said. "As a consequence, our independence might be called into question, and rightly so." Bank of France Governor Francois Villeroy de Galhau said at the same event that because the ECB's approach to its goal is "symmetric and medium-term" it can achieve similar outcomes to average inflation targeting. That's in line with previous signals that he's open to letting inflation rise above the target.

BLOOMBERG