ECB’s Lane: Objective Is to Ensure Yield Curves Don’t Get Ahead of Economy

16 March 2021

By David Barwick – FRANKFURT (Econostream) – The European Central Bank’s objective is to ensure that yield curves do not get ahead of the economy, ECB Executive Board member Philip Lane said on Tuesday.

In an interview with Financial Times posted to the ECB’s website, Lane, who is also chief economist, said that internal analysis showed that the ECB ‘could do more in terms of providing additional stimulus’. Still, while the ECB hasn’t reached the lower bound and thus ‘could lower the deposit rate’, he said, ‘there is clearly less room to deliver monetary stimulus when interest rates are already low’.

The ECB changed its focus to preserving favourable financing conditions out of efficiency, he said. ‘[R]ather than focus on pushing down the curve compared to the mid-December level, monetary accommodation could be better provided by preserving favourable financial conditions, especially in responding to a tightening that would be inconsistent with offsetting the pandemic shock to the inflation path’, he said.

At the time of the December monetary policy meeting, the curve of risk-free rates going out ten years ‘had never been so flat’, he said.

Lane agreed that a tightening was occurring, ‘and our objective is basically to make sure that yield curves – which play an important role in determining overall financing conditions - do not move ahead of the economy.’

The forward-looking nature of financial markets means ‘you can have a steepening in yield curves which is not conducive to maintaining progress in terms of the inflation dynamic’, he said. ‘It is really a shift in monetary policy away from focusing on just the short-term rate by looking at all financing conditions. For many economic decisions, especially under the conditions we have now, the longer end also matters.’

How the ECB assesses the favourability of financing conditions depends on progress with respect to projected inflation, he said. It is not yield curve control because the fixed value implied by such a policy changes with ‘the relation between the appropriate level of yields and inflation’.

According to Lane, yield curve control for the ECB would be superfluous, given that at the two-to-three-year horizon typical for the practice, markets and surveys already suggest no expectations of a rate hike. The ECB’s forward guidance has thus already ‘secured that two-to-three-year part of the yield curve’, he said.

As for committing to a fixed value, that ‘seems unnecessary’ in the current ‘highly dynamic context, where you know there is going to be a recovery’, he said. ‘The important point here is that we provide enough monetary accommodation to make sure that financing conditions are favourable so that the pandemic shock to inflation is offset and we deliver a path to convergence with the inflation target.’

Any economic agent dependent on medium- to long-term financing ‘should be reassured’ by the ECB’s intention to ‘look past most of’ inflation volatility, he said.

‘What is most important is converging to the target in good time, with the speed of convergence ensuring that inflation expectations do not drift further away from the target’, he said. The circumstances require both ‘decisive action to keep up the inflation momentum’ and the recognition that ‘patience is required’, he said.

In contrast to 2015 and 2017, now ‘there is definitely an intention to secure the recovery’, he said, citing the EU recovery fund. ‘It is not just about getting through the pandemic. In this context, you might be more optimistic about inflation dynamics, even if the pandemic itself is definitely a severe negative.’

Lane said he saw ‘a very strong logic’ to signalling that the correction after a period of under-target inflation will involve ‘going moderately above the target for a period.’ Inflation of 2% has not ‘necessarily been seen as a ceiling’, given ‘plenty of overshooting periods in the past’, he said.

Once the public health situation no longer requires containment measures, ‘you should expect to see a very large recovery’ such as in 3Q of last year, he said. ‘Once we get better control of the virus we should expect to see most of the economy just go back to normal.’

By mid-2022, output will have regained the levels of 2019, he said, reflecting ‘the unique nature of the pandemic.’ All the fiscal and monetary accommodation is precisely so as not to prolong the temporary impact of the pandemic by being too cautious, especially since the policy support is ‘only for a relatively short period of time’, he said. ‘I am not putting the long-term damage to zero, but it is relatively contained.’