ECB’s Lane: Can’t Let Pandemic Result in Lower Inflation for Longer

6 October 2020

By David Barwick – FRANKFURT (EconoStream) – European Central Bank Executive Board member Philip Lane on Tuesday reiterated his opposition to allowing the pandemic to result in a lengthy period of lower-than-previously-expected inflation.

In a speech at the NABE Annual Meeting, a text of which was made available by the ECB, Lane, who is also Chief Economist, suggested that EONIA-based expectations of the eventual lift-off date for ECB interest rates were consistent with forward guidance.

Accepting the longer period of low inflation caused by the economic fallout from the pandemic, along with the resulting delay in restoring price stability, ‘is not desirable for a number of reasons’, he said, echoing his own remarks from the Jackson Hole Economic Policy Symposium end-August.

Besides the cost imposed by higher real interest rates, this option would be ‘high risk’, he said: ‘[B]y tolerating a protracted period of even lower inflation, it might foster a downward drift in inflation expectations that could ultimately become entrenched, making it even more difficult for us to deliver our inflation aim.’

The preferable option is thus ‘to add sufficient extra monetary policy accommodation to boost inflation momentum’ and return to the path of inflation from before the crisis, he said. The ECB’s pandemic emergency purchase programme is the ‘central element’ in this first stage of the monetary policy response, he said.

In a second stage, ensuring that inflation does indeed converge to the ECB’s objective implies an ‘appropriately calibrated’ policy stance, he said. ‘To these ends, the ECB Governing Council stands ready to adjust all of its instruments, as appropriate.’

With respect to restoring price stability, the amount of accommodation needed ‘depends on the extent of the fiscal support for the economic recovery’, he said.

Lane reiterated the ECB’s forward guidance on interest rates, according to which ‘the Governing Council expects to keep policy rates at their current or lower levels until we have seen the inflation outlook robustly converge to our inflation aim within our projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.’

This means, he elaborated, ‘that we require a high degree of confidence that the inflation outlook has durably approached the inflation aim, while the condition that convergence should also be evident in realised underlying inflation means that future rate tightening will not run ahead of the hard data in terms of the out-turns for underlying inflation.’

This amounts to a ‘double hurdle’ that needs to be surmounted before tightening can occur, he said, and thus ‘represents a strong commitment to keep financial conditions at highly accommodative levels for as long as necessary to lift inflation to our inflation aim in a sustainable fashion.’

Citing the implications of the EONIA forward curve for when rates would start to rise and net purchases under the asset purchase programme (APP) would end, Lane suggested that market expectations were consistent with the ECB’s forward guidance.

‘Through these endogenous market responses, our forward guidance acts as an automatic stabiliser through the adjustment of monetary policy expectations – and hence the entire spectrum of monetary conditions – to changes in the inflation outlook’, he said.

Noting the high take-up of the ECB’s third series of targeted longer-term refinancing operations (TLTRO III), and banks’ expressed intentions to lend these funds, Lane said predicted the instrument would have ‘a sizeable impact on the provision of financing by banks to their customers.’ TLTRO III liquidity would lead to a cumulative three-percentage-point rise in loan volume by 2022, he said.

HICP would remain in negative territory for the rest of 2020, he said. ‘The elevated level of economic slack, weak energy inflation and the recent appreciation of the euro are expected to continue to act as headwinds’, he said.

Half of the total loss in output during the first half of the year was regained in the third quarter, he said, but the recovery is hampered by both supply chain disruptions as well as weak demand in the face of high uncertainty for businesses and households. Rising Covid-19 case numbers are reflected in the deceleration of the services sector, he said.