July 22, 2021 | 09:49
ECB's New Forward Guidance Pushes Any Hike/Taper Far Into the Distance
The ECB's 2% inflation target is not a ceiling. It looks pretty far from reach right now and the way the new guidance works, it will be a long time before rates rise.
Here's the old forward guidance: "The Governing Council expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics."
Here's the new forward guidance: "In support of its symmetric two per cent inflation target and in line with its monetary policy strategy, the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at two per cent over the medium term. This may also imply a transitory period in which inflation is moderately above target."
Spot the difference? Note the phrases I (not the ECB) bolded. The focus is now on actual inflation, rather than inflation expectations. And the run-up in inflation is expected to be mostly temporary and the factors driving prices (base effects and energy) should fade by early 2022. President Lagarde patiently went through the new guidance and emphasized its three "legs" or "criteria":
Interesting given that, as of last month, the ECB's inflation forecasts were 1.9% for 2021, 1.5% for 2022, and 1.4% for 2023. For 2022 .... 1.5% is not even close to 2%. Also, price pressures are still expected to "remain subdued for some time" and though inflation is expected to rise over the medium term, they will still "remain well below our target." Gee, what does that mean for rates?
And that was just on interest rates... all the above just confirmed our view that rates aren't going anywhere for a long time. How about asset purchases? The PEPP, the APP? The programs weren't discussed and although President Lagarde noted that risks to the outlook were still broadly balanced, the outlook depends much on the pandemic and the vaccinations. She also pointed out that the Delta variant could dampen the recovery. And, no one wants to tighten prematurely. Got it. No tapering.
Bottom Line: I'm paraphrasing but President Lagarde's words were "I wouldn't say lower for longer but the guidance is an indication that none of us want to tighten prematurely … would be detrimental……… patience is needed". That said it all. So.... no hike, no taper.