ECB’s Lane Greatly Plays Down Significance of Euro’s Exchange Rate

12 October 2020

By David Barwick – FRANKFURT (EconoStream) – European Central Bank Executive Board member Philip Lane on Sunday strongly downplayed the importance of the euro’s appreciation and said the exchange rate should not be at the centre of policymaking.

In an interview with the Wall Street Journal, a text of which was made available by the ECB, Lane, who is also Chief Economist, indicated clearly that information gained during the autumn would decide whether additional stimulus was needed.

Asked how concerned he was by the exchange rate, Lane said that economic slack was ‘by far the biggest issue for inflation’ and noted the role of oil prices as well. As for the exchange rate, it ‘is important for the European economy, there is no doubt about that’, he said. ‘But there's a lot going on at the moment and it's important not to put that at the centre of policymaking, because it's not.’

The exchange rate is of importance less per se than in terms of its impact on economic and inflation developments, he added. The ‘significant’ economic recovery in China and the improvement of the global economy over the last few months are both ‘quite important’ factors, while policy support and the reopening of European manufacturing’s are ‘important’, he said.

‘So the exchange rate is important but the bigger global issue is the state of global demand, and that has recovered maybe better than expected’, he said.

More than the level of the exchange rate, it’s the movement that matters and the implications of this over the medium term rather than from month to month, he said. ‘So it’s something we’re looking at, but there’s so much going on in the world right now, it’s just one of many factors. And compared with the core issue, which is the pandemic itself, it in no way ranks in the same category as that.’

The need for more accommodation ‘depends on the incoming data’, he said. ‘It is clear that 1.3% is not our goal. More than usually the incoming data will tell us a lot. Right now, there’s a lot to learn in these weeks.’

That the pace of the recovery would change after the early snap back was ‘always clear’, he said. How the pandemic evolves, and with it consumption and investment, would determine its strength.

‘It really is a unique period of uncertainty’, he added. ‘But along some dimensions the uncertainty will diminish in the autumn because we’ll know more about the outlook for 2021.’

Asked if the December 10 monetary policy meeting of the Governing Council could be key, Lane suggested not focussing ‘on any one meeting. It’s not the case that we only look at the formal projection rounds.’

Lane indicated a reluctance to take interest rates further into negative territory. The shock from the pandemic should be mainly temporary and the impact on output ‘mostly gone by 2022’, whereas ‘[a]ny interest rate cut typically lasts for a long time’ because the entire yield curve shifts in response, he argued.

‘The value of a rate cut is still there and we look at it all the time,’ he continued. ‘It’s perpetually looked at. We reject the idea that we are at the lower bound. ‘

Although another rate cut would still have the usual effect, asset purchases are currently more effective, he said. ‘But the option of going lower remains part of our policy guidance.’

Currently negative inflation rates are due to ‘some purely temporary factors’ such as the German VAT reduction and the ‘huge amount of slack’ in the economy, he said. Given ‘there’s going to be a lot of reduction in slack next year, he said, ‘inflation is going to climb.’

Although the ECB is far from its price stability objective and not satisfied with the outlook, the next few weeks will bring a lot of relevant information regarding national budget announcements, the exchange rate, oil prices and the pandemic, he said.

‘So I think it’s true to say that we would like to see a stronger momentum in inflation’, he said. ‘Meeting by meeting we will have to make that call: where do we think inflation is going? Because if the outlook remains at 1.3%, that is far away from our goal.’

From the point of view of the economic outlook, ‘[t]he single biggest risk is that the pandemic is not controlled, and/or it takes longer than is currently expected to find good treatments and a vaccine’, he said. ‘That outranks any other risk by some distance.’

Maintaining policy support is important to avoid worse outcomes, he said, ‘[a]nd I think that's going to remain true until the pandemic is really vanquished.’

The next phase of the economic recovery ‘is going to be tougher’, he said. About half of the decline in output during the first two quarters has been reversed already, with a further gain in the fourth quarter expected to leave Europe’s economy about five percentage points below its level at the end of last year, he said.

‘Our baseline is still a lot of recovery in the fourth quarter, a lot of recovery next year, with the elimination of the whole gap in 2022’, he said. The current resurgence of the pandemic is within the baseline, he indicated, so the ‘big question’ is the speed with which the situation can be stabilized.

‘If it's shown that you can control the virus with serious but not universal restrictions, then that's more or less in line with our baseline’, he said. ‘If it turns out we have to really disrupt the economy more materially in order to control the pandemic, then that’s more of a negative development.’

Lane said there was a ‘reasonable concern about whether firms will survive and whether people's job prospects will be damaged’, and that this would continue to motivate precautionary savings.

Turning to the ECB’s strategy review, Lane observed that the formulation chosen by the U.S. Federal Reserve to anchor expectations is just one of a ‘whole family of different ways of doing this.’ The ECB’s current forward guidance, he appeared to suggest, offers clues as to the path the ECB might take.

The ECB already stipulates that higher interest rates presuppose a robust convergence of inflation to the objective and that this convergence has to be visible in realised inflation dynamics, he said. ‘It’s not just that we’re forecasting two years from now that inflation is going to pick up, but that we’ve already seen a good pickup in underlying inflation.’

The ECB’s current forward guidance is thus like the ‘family of policies which all say: we’re not going to have knee-jerk policy tightening, we’re going to make sure that inflation is in the neighbourhood of where we want it to be before we tighten’, he added.

Lane denied that the ECB would find it hard to withdraw support in the context of high government debt, reminding that the inflation outlook would be the driver of such decisions. ‘That’s an important signal to governments’, he said. ‘The interest rate policy is crystal clear and if the conditions in respect of inflation warrant a tightening of policy, that’s what the ECB is going to do.’

However, he added, those conditions would include good economic performance and no slack, circumstances under which fiscal policy would be more easily able to cope.

Similarly, the inflation outlook will also decide when the ECB can roll off its bond holdings, he said, though purchases made under the pandemic emergency purchase programme (PEPP) would be handled differently and in any case in a manner that does not interfere with monetary policy.

‘But it’s also clear that the PEPP is a temporary measure’, he said. ‘If the monetary conditions allow it, these portfolios will be rolled off. This is fundamental to protecting our independence.’