In early July, the ECB shook the foundations of monetary stability in the Eurozone with a bold departure from its historic framework. In response to a protracted deflationary threat, the Bank ripped up the rulebook and decisively changed expectations about its future policy actions with profound implications for the pricing of corporate and government securities denominated in euros.
Oh hang on, that’s completely untrue. Instead, in a highly telegraphed move, the ECB decided to switch its inflation target from “below but close to 2%” to “2%”. Radical stuff.
This was the first monetary policy strategy review since 2003. Back then, the ECB shifted its inflation objective to “below but close to 2%” from “below 2%”. Watching paint dry is often more exciting, and certainly less time consuming, than following this painful incrementalism.
It is hard to read this stuff without being reminded of the similarly tortuous journey of the Bank of Japan (BoJ). In 2006, the BoJ introduced an “understanding” of price stability as inflation in “a positive range of 2% or lower”. In 2012, that was upgraded to a “price stability goal” of inflation “within a positive range of 2% or lower”. In 2013, that was upgraded again to a “target” of inflation at 2%.
If you want (and I don’t advise it), you can read the BoJ’s explanation of why switching from its “goal” to a slightly higher “target” was a big deal. Similarly (and again, I don’t advise it), you can read an ECB overview of its newly announced strategy. The ECB President Christine Lagarde insists that “quite a lot” has changed. We are less convinced.
Alongside the target tweaks, we’ve also been told that the ECB will take “into account the implications of climate change and the carbon transition for monetary policy and central banking”. It’s a worthy aspiration, but a total mystery what that implies outside its corporate bond portfolio.
As macro investors, we really care about whether the policymakers have done anything to change the entrenched low inflation expectations that have become the norm in the Eurozone. This is not an abstract concern. Weak inflation expectations undermine nominal earnings growth, keep bond yields suppressed, and put unwelcome upward pressure on the exchange rate. Can the ECB change any of that?
The first reason to be sceptical is that the ECB Governing Council members are not all on the same page. In a blizzard of double negatives, Bundesbank chief Jens Weidmann made it clear that the ECB’s strategy tweak is very different from the Federal Reserve’s more significant shift last year: “We do not make our monetary policy contingent on targets not met in the past.” For the ECB, bygones are still bygones.
Second, there is no magical mechanism whereby tweaking central-bank targets and operating frameworks impacts wage and price-setting behaviour in the real world. In the eight years since the BoJ upgraded its 2% inflation target, realised inflation has averaged a paltry 0.6%. Shifting the target has incentivised the BoJ to launch a series of increasingly extraordinary interventions culminating in “Quantitative and Qualitative Easing with Yield Curve Control” in 2016, but it has done very little to change the dial on actual inflation.
Third, while macro investors hang on every announcement and adjustment from central banks, it totally bypasses most normal people. A telling Pew survey in 2014 revealed that less than 25% of the US public could name the Chair of the Federal Reserve, even when given a shortlist of just four names! If people don’t know who is running their central banks, why are they expected to care if there is a minor adjustment to the monetary framework?
And finally, the ECB can change its monetary framework. But the fiscal framework is determined in Brussels and Berlin, not in Frankfurt. Europe has suspended its fiscal rules, but the straitjacket is likely to be tightened from 2023 onwards. In a recent interview, there was a very clear message from the CDU’s Armin Laschet that there is little enthusiasm for abandoning European fiscal orthodoxy anytime soon. The contrast with the US is, once again, striking.
All in all, it seems to us a case of “Much Ado About Nothing”. Or, as Christine Lagarde herself might put it, “plus ça change, plus c'est la même chose”.