ECB’s New Strategy Emphasizes ‘Forceful’ Responses to Inflation Shifts
The central bank was criticized for being too slow to respond to a pickup in inflation in 2021
The European Central Bank said it will respond in a “forceful or persistent” manner to big swings in inflation, reflecting the lessons learned from the postpandemic price surge in its latest strategy review.
In common with other central banks, the ECB was criticized for being too slow to respond to a pickup in inflation in 2021 when the annual rate peaked at above 10% by late 2022.
Central bankers concede that they underestimated the effect of interruptions to supply on prices, having been more used to focusing on demand surges as a source of inflation.
“Appropriately forceful or persistent monetary policy action in response to large, sustained deviations of inflation from the target in either direction is important,” the ECB said.
The ECB began to raise its key rate in July 2022 and brought that sequence to an end in September 2023, having increased borrowing costs by 4.5 percentage points.
In a news conference, ECB Chief Economist Philip Lane described that aggregate move as “forceful,” while keeping the key rate at 4% until June 2024 was an example of persistence.
The ECB said the outlook for inflation has become more uncertain as a result of geopolitical and economic fragmentation, the increasing use of artificial intelligence, demographic change, and threats to environmental sustainability.
“A lot of this is in the direction of rolling back globalization,” Lane said.
Lane said that at the time of the last strategic review that began in 2020, globalization was a factor helping keep inflation low.
“We think that what we may be faced with is larger deviations from our 2% target in both directions,” he said.
The bank’s goal will be to ensure that, as events push prices sharply higher or lower, households and businesses don’t respond as if those moves were going to be long-lasting, and demand higher wages or push prices even higher.
“This will help to avoid inflation expectations becoming de-anchored and inflation deviations from the target becoming entrenched,” the ECB said.
Central bankers worry that the surge in prices that followed the Covid-19 pandemic and Russia’s full scale invasion of Ukraine has increased the risk that inflation expectations will quickly shift above or below the 2% target in the event of a new shock.
In a report published Sunday, the Bank for International Settlements said a recent survey of households in 29 advanced and emerging-market economies found that expected inflation is “significantly higher” than the current pace of price increases.
The BIS, which is owned by most of the world’s leading central banks, said the fragmentation of the global economy as tariffs rise could lead to a new breakdown in the supply of goods.
“As the pandemic-era inflation experience made clear, disrupting supply chains could once more lead to upside surprises in inflation,” it warned. “Such a jolt to inflation could rekindle inflation expectations that remain sensitive after the Covid-19-related inflation experience.”
By responding “forcefully” to future shifts in inflation, central bankers hope to reassure households and businesses that they won’t experience a repeat of the postpandemic surge.
In the immediate future, the ECB faces a potential jump in energy prices if the conflict in the Middle East intensifies. In the U.S., the Federal Reserve worries that prices might rise as a result of higher tariffs.
“The [Federal Open Market Committee]’s obligation is to keep longer-term inflation expectations well anchored and to prevent a one-time increase in the price level from becoming an ongoing inflation problem,” Fed Chair Jerome Powell last week told the House Financial Services Committee.