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Covid is prompting some officials to push for a more ambitious strategy review by the ECB.
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The European Central Bank's strategy review is seeing a debate over how much a new monetary policy framework should allow for responses to extreme situations such as the Covid pandemic, while a tussle continues over how to define a new "symmetrical" inflation target, Eurosystem sources told MNI.
With September seen as an informal deadline for concluding the review, some national central bank governors want the new strategy to not only clearly give room to policies such as the EUR1.85 trillion Pandemic Emergency Purchase Programme, but also guide decisions over what follows once it concludes net purchases next March. Others want a more stripped-down mission for the ECB.
"I think that those who defend that the review should reflect, or be useful for, these [pandemic] circumstances are winning the argument," one Eurosystem official said, speaking after the review featured in an annual retreat for Governing Council members earlier in June. But he admitted other central banks had fought back hard. "The process has been exhausting. Taking PEPP out, or wanting to leave PEPP out, makes things more difficult. You can't ignore it because it is the key tool for the current situation. The new review can help on solving the post-PEPP scenario."
READY BY SEPTEMBER
Another source familiar with proceedings said the strategy review would have to produce language able to encompass the extraordinary action to support government bond markets during Covid, which suppressed spreads for less fiscally robust parts of the eurozone in particular.
"If you say 'now we want to counter fragmentation' suddenly during the Covid period and then suddenly after the Covid crisis we go back to the old framework, that just doesn't work. So, you have to be very careful how you articulate that," the source said.
Officials are eager to conclude the review by September, when the Governing Council will need to focus on the PEPP as its active phase nears completion. But while there is broad agreement that the current inflation target's definition as "below, but close to 2%" should be replaced with a plain 2% objective, talks over how to define its symmetrical nature have proven tough.
"My concern is now that we find a compromise set of words that suits everyone rather than a compromise framework that is a strong policy," one Eurosystem official said. "On the inflation target overall, those points are what would be considered the low-hanging fruit. Finding an overall agreement on what symmetry should be is proving much more difficult."
With more conservative review participants noting the questions raised about the Federal Reserve's new average-inflation-targeting strategy after the hawkish shift in its most recent rate-hike projections, debate on how to specify a policy which responds equally to overshoots and undershoots of the inflation target has included how to balance language which is easily comprehensible and yet as flexible as possible.
"One issue is how much of an overshoot, and for how long? And how do you compensate for that in different regions and areas?" another Eurosystem official said. "There is the output gap, there is the asymmetry of growth. What are you going to do if you have inflation at 4% in some countries?"
Bank of Finland Governor Olli Rehn has expressed support for a Fed-style strategy, but a compromise approach might be for the new framework to emphasise the role of guidance, said the source familiar with the debate, echoing comments by Bank of France Governor Francois Villeroy de Galhau.
"If some governors do not like a very strong strategy review – in terms of how do you achieve price stability and a U.S.-style-strategy, you could put it in guidance, which is less structural," the source said. "This accommodates those hawks who are reluctant to change too much."
One option for ECB president Christine Lagarde, according to this source, may be to release early rough agreements of the strategy review at the July meeting, leaving them to be fine-tuned later. "You make a narrative communication of the strategy and in September you deal with the economy and the tapering discussion," the source said.
Discussions on another issue, incorporating climate objectives more explicitly into the ECB's secondary mandate, which calls for it to support the EU's economic policies, are progressing more easily, another official said. But details remain to be sorted out.
"If it's included in the secondary mandate, and then some other issues are also included in the secondary mandate, there might be a clash in terms of how to build the hierarchy. Is this secondary mandate goal more important than this secondary mandate goal? So that might be a problem," the official pointed out, stressing that the two sides were not far apart.
"There is a common understanding, and also an understanding of the other side," the official said. "What they are trying to do at the moment is to hammer out the details."
An ECB spokesperson declined to comment on the matters in this article.