Prolonged weakness in the labour market will offset inflationary pressures in the euro area, Philip Lane, the European Central Bank’s chief economist, told an OMFIF briefing on 5 May. As a result, the ECB is ready to maintain large-scale asset purchases if warranted by economic and financial conditions. Lane also hinted that the ECB may adapt its stance on ‘market neutrality’ in corporate bond purchases as part of its strategy review due to be concluded in September.
Asked if inflation could durably overshoot the bank’s target in the next 18 to 24 months, Lane – the board member responsible for economics – said: ‘I really don’t see that as a likely outcome. A precondition for persistent inflation is a strong labour market. Changes in commodity prices or the pricing power of companies are not enough in their own right. We expect the labour market to take longer than the economy to recover from the pandemic.’ Gross domestic product is forecast to return to 2019 levels next year, while employment will not fully recover until at least 2023, he said.
Lane thought inflation is unlikely to rise durably and significantly above its current level, despite the US beginning a near $2tn stimulus package since the ECB’s last forecast meeting in March. A lot of the changes in the global economy, as well as Europe’s progress with vaccinations, had been factored into the bank’s guidance, and the US stimulus had to be looked at in a global context, where – as one example – the state of the pandemic in India would have a dampening effect. Although the exchange rate would have an impact on Europe’s overall economy, he played down any question that a weaker euro against the dollar could have an impact on accelerating price rises.
He described inflation as a ‘mostly domestic phenomenon’. A lot of recent inflationary pressures were, in effect, unwinding the negative shocks of last year. Lane reiterated that he expected euro area inflation to sit around 1% next year, rising to roughly 1.4% in 2023. Answering a question referring to a temporary blip in German inflation to above 3% later this year, he indicated that the ECB would prefer to have German inflation somewhat above the average level for the euro area. This would allow other countries to catch up on competitiveness as measured by the real (inflation-adjusted) effective exchange rate.
He said patience would be required as inflation picks up and the ECB was considering how it could use forward guidance to emphasise its commitment to a return of inflation to its longstanding reference level or target of below, but close to, 2%, even if price rises were temporary. The strategy review is widely expected to set a symmetrical price target of 2%, removing the reference to ‘below’.
Lane left open the possibility that the pandemic emergency purchase programme could continue beyond its slated expiry in March 2022. The ECB’s goal was to ensure ‘favourable financing conditions’ until the end of the crisis, he said, and the governing council would determine when that support was no longer necessary. The ECB would continue to either increase or decrease its net PEPP purchases, running at around €80bn a month. ‘Quantitative easing has been subordinated to maintaining favourable financing conditions. This is not an approach focused on volumes. It’s like adjusting interest rate policy. This is a long-end version of that.’
Lane acknowledged the increasingly important role that fiscal policy will play alongside monetary and economic policy in Europe’s recovery but insisted the clear boundaries between central banks and finance ministries would remain, describing their relationship as one of ‘interdependence rather than coordination’.
The ECB will stick to its plan of ending net asset purchases before increasing interest rates, but the bank would remain ‘philosophical’ about it. He noted that the Bank of England was reviewing whether the logic behind this sequencing is robust and that the ECB was examining the process as well.
Lane described the ECB as being in ‘listening mode’ during its comprehensive strategy review, the bank’s first since 2003, including with its staff through town hall meetings, as well as with outside stakeholders. The bank is clearly heeding calls for it to be more energetic in the fight against climate change. Lane pointed out that the corporate bond market, where the ECB has been an active buyer, does not reflect the make-up of the broader economy, as it is not accessible to smaller firms.
In fact, the bigger corporates active in the bond market are typically the largest carbon dioxide emitters. This was a strong hint that the ECB would take a more determined line in steering bond purchases towards companies with relatively low carbon dioxide footprints. He said the ECB was looking at the logic of market neutrality in this context and that the term needed to be better defined.
Lane commented guardedly on lawsuits before the German constitutional court, some of which refer to previous judgments of the European court of justice, querying the constitutional validity of the PEPP, on the grounds that the programme allegedly encompasses illegal monetary financing. Pointedly referring to the European but not the German court, Lane said the ECB, like all central banks, had to respect ‘legal frameworks’ but also was empowered to act within its ‘treaty mandate’ of upholding price stability.