ECB’s Lane: Severe Scenario Didn’t Really Have Inflation Negative

1 July 2020

By David Barwick – FRANKFURT (EconoStream) – Even the European Central Bank’s gloomiest scenario does not truly envision deflation, ECB Executive Board member Philip Lane said Wednesday.

In an interview with Reuters, the text of which was published on the ECB’s website, Lane, who is also Chief Economist of the ECB, cautioned against extrapolating from data that would be largely positive in the coming months.

The better-than-expected June inflation reading ‘doesn’t tell you all that much about inflation in the medium term’, according to Lane, who said that even the ECB’s worst-case scenario ‘didn’t really have inflation going negative’. While such a risk ‘is there’, the ECB envisions inflation staying very low but positive, he said.

On Tuesday, Eurostat said its first estimate of euro area annual inflation for June was 0.3%, above expectations calling for no change from May’s 0.1%.

Lane’s apparent optimism stands in possible contrast to a more pessimistic sentiment expressed by his Executive Board colleague Isabel Schnabel, who just Saturday said that the short to medium term would only bring a gradual economic recovery, during which ‘[i]nflation could remain at close to 0% well into the next year, and even negative inflation rates are possible.’

Indeed, Schnabel’s assessment was supported by a slide showing the range of estimates of annual HICP covering a mild to a severe evolution of the crisis and clearly encompassing readings as low as about -0.2% for a period of about half a year into early 2021 in the severe scenario (the baseline scenario narrowly skirts minus territory).

Lane urged observers to ‘settle in and recognise that there isn’t going to be full clarity about the medium term for many months.’ While we are seeing an ‘initial bounce’ back from the bottom that will entail ‘a long period where the data should be mostly positive’, this phase doesn’t ‘really provide a guide to what’s going to happen in the winter’, he said.

The ECB has ‘multiple exit strategies’, Lane insisted, citing the condition – a robust convergence of inflation to the bank’s definition of price stability - under which the ECB would exit from its asset purchase programme (APP) and negative interest rates. ‘On the PEPP [pandemic emergency purchase programme], we will end the purchases when we conclude that pandemic crisis phase is behind us’, he said.

He rejected the notion that national governments’ indebtedness would prove an insurmountable obstacle to an exit. ‘This idea that debt levels trap us, I just don’t see it’, he said. ‘I am confident that when we have the conditions which we laid out in our forward guidance, when those conditions apply, then we can move and exit.’

Although rating agencies could yet impose widespread corporate downgrades – or not – the data available right now ‘are not compelling to say that there should be a lot more downgrades’, he said. The ECB’s approach to the associated topic of buying corporate paper below investment grade is ‘contingent on the data we see’ he said. He added, though, that ‘the scale of the improvement in market stability has already delivered quite a lot.’

The ECB is ‘not, absolutely not, into yield-targeting or yield-curve control’ Lane said. Rather than take ‘any particular view on the level of the spread’, monetary authorities consider whether markets have become one-sided, ‘which you know will lead to overshooting’, he explained.

The central bank’s efforts to stabilise markets in such a situation says nothing about the level of the yield per se, he continued, since that would not be credible in the absence of a commitment to buy everything. ‘We announced a substantial programme and we said we’re going to use it flexibly’, he said. ‘But in no sense it’s a kind of promise to deliver any particular type of spread.’

The announcement of the PEPP on March 18 caused yields to decline sharply, ‘because what mattered to the market was that it was no longer one-sided’, he said.