monetary policy

ECB readjusts monetary policy course

Philipp Jäger

Philipp Jäger

Berenberg

ECB President Lagarde presented the results of the ECB Strategy Review – the realignment of the monetary policy strategy in the Eurozone – on 8 July. The innovations are to first apply at the Monetary Policy Meeting on 22 July 2021.

New inflation target 

It had already become clear that the ECB’s inflation target, which has so far been “close to but below 2 %”, would in future be set at a (medium-term) target value of exactly 2 % with a symmetrical tolerance zone (i.e. with moderate upward and downward deviations), which has now been officially confirmed. According to our chief economist, however, this target calibration is not likely to have a significant impact on the current monetary policy stance, but should rather be seen as codifying what the majority of Council members have been working towards in the recent past anyway. First and foremost, the inflation target is a communication tool, which in its new form should now become clearer and more tangible for market participants.

Owner-occupied housing taken into account

Furthermore, the central bank plans to change the calculation methodology of the inflation rate that is decisive for monetary policy – the harmonised consumer price index – to the effect that in future the inflation of owner-occupied housing will also be taken into account. Since the technical implementation of this new item is likely to take several years, the ECB will initially resort to estimated values. Although such an adjustment of the calculation methodology will certainly better reflect reality, market participants should not necessarily expect significant effects on the inflation rate, as the ECB itself points out in an Economic Bulletin from 2016. Earlier comments by the ECB also suggest that at best moderate effects of +20 to +30 basis points are to be expected, while Bloomberg analysts even assume a mere +10 basis points.

But it is not only in terms of inflation targeting that a new monetary policy course is being set; the issue of climate protection – as expected – will also find its way into monetary policy.

Climate protection aspects and monetary policy

However, the central bank’s statements in this regard are not particularly concrete. The ECB has only presented an action plan showing which adjustments are to be made in the future. The direction of the plan can be outlined as follows: in addition to a comprehensive inclusion of climate factors in monetary policy assessments, the ECB Governing Council will adjust the design of its monetary policy framework, especially with regard to the topics of disclosure and risk assessment, and make climate-relevant adjustments to its corporate bond purchase programme CSPP and the ECB collateral framework.

Lack of detail leaving markets in the dark

Why the central bank remains so vague about this after taking 18 months for its Strategic Review is incomprehensible to us. Thus, to what extent the monetary integration of the climate issue will have a major impact on the bond markets remains to be seen. In view of this, we can only repeat our basic scenario at this point: We assume that the ECB will overweight green bonds and particularly environmentally friendly issuers in its purchasing programmes in the future (and thus deviate from market neutrality). In addition, the central bank could allow further sustainable financial instruments in its collateral framework (such as sustainability-linked bonds recently) and impose a haircut malus on particularly climate-damaging bonds. Against this background, bonds with a sustainability focus are likely to remain outperformers.

Market reaction restrained 

Initial reactions in the bond market to the results of the policy review have been subdued. We believe that caution in interpreting the new inflation target is appropriate. As is usual with such strategy adjustments, only time will tell how the new targets will be implemented in practice. It is therefore likely to take some time before market participants fully understand the implications of the new targets and how the central bank’s future reaction function to inflation looks like.