FRANKFURT (Reuters) – The European Central Bank is launching a fresh strategy assessment seen covering some big questions on the way it works – from whether massive bond buys remain a good policy tool, to what role it should play in the fight against climate change.
These are the policy areas likely to be under review before a final report due around mid year which could bring incremental shifts in policy:
BOND BUYS
Bond buys or quantitative easing was a key plank of ECB policy in the decade before the pandemic but some policymakersare openly questioning its merits.
The ECB bought trillions of euros worth of debt in the hope of boosting inflation when price growth was too low but 4 trillion euros of these assets are still on the books, years after stimulus ended, since it takes years to unwind the buys.
“As bond holdings can be unwound only gradually, asset prices will remain distorted for a long time,” ECB board member Isabel Schnabel said late last year. “It means that the bar for starting QE should be higher than in the past.”
Some policymakers want the ECB to acknowledge that quick bursts of bond buys are effective, like during the pandemic, but costs outweigh benefits in case of lengthy purchases.
While profits are not a core activity, massive QE also left the ECB with record losses, depriving governments of dividend income.
Since the ECB made clear it would intervene in markets if policy transmission was impaired, some policymakers have also called for a clearer distinction between instruments used to fight inflation and those aimed at market stability.
ESPECIALLY FORCEFUL ACTION
The review will steer well clear of questioning the ECB’s main goal of targeting inflation at 2% but could broach whether, in future, falling just short of that threshold is so bad that it requires extraordinary measures.
The ECB’s strategy calls for “especially forceful” action when inflation is too low, suggesting that undershooting is seen as a bigger problem than overshooting.
But evidence suggests that prices tend to be rigid on the way down, so only huge shocks lead to outright deflation.
Even during the ultra low inflation decade before the pandemic, firms and households continued to expect modestly rising prices.
If the ECB is serious that its 2% inflation target is symmetric, then there should be no distinction between the approach to under and overshooting, some argue.
Especially forceful action, since it normally means copious bond buys, also sows the seeds of financial distortion.
CLIMATE
The ECB committed to an “ambitious” climate action plan in 2021. But achievements have been limited.
It tilted corporate reinvestments toward firms with better climate performance but those reinvestments have long ended.
While it promised it could still adjust its remaining corporate bond portfolio based on climate considerations, the bank faces a more existential question on what sort of role it should play in climate policy.
The U.S. Federal Reserve recently left the Network for Greening the Financial System because its work had broadened beyond the Fed’s mandate. ECB chief Christine Lagarde defended the NGFS but some, including Belgian central bank chief Pierre Wunsch, have called on the ECB to limit its climate role to avoid interfering with policymaking.
FORWARD GUIDANCE
The ECB kept forward guidance, or commitments about future policy action, as part of its toolbox in its last review in 2021. Such guidance, however, slowed its reaction to the rapid rise in inflation in 2022, since the bank had already committed to loose policy.
Policymakers have since argued that forward guidance should only be used when interest rates are at the lowest effective level and the ECB should otherwise curb its use.
(Reporting by Balazs Koranyi, Editing by Alexandra Hudson)
