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ECB Aims For Slightly Higher Inflation in New Policy Framework

07/08/2021 | 05:35am EDT

By Tom Fairless

FRANKFURT--European Central Bank officials forged an agreement on a new policy framework over the longer run, aiming for slightly higher inflation in a region that is struggling to emerge from the severe Covid-19 recession, but stopping short of the major policy shift unveiled last year by the Federal Reserve.

The ECB's policy changes, its first in nearly two decades, represent a compromise between conservative policy makers in northern countries such as Germany, who tend to worry about high inflation, and those in Southern European nations such as Italy who are more concerned about weak economic growth.

The ECB said it would aim to keep eurozone inflation at 2% over the medium term, instead of the current target of just below 2%, and would allow room to overshoot its target when needed. It also said it would move to incorporate house prices into its calculation of the inflation rate, and would support efforts to combat climate change via its bond-purchase programs and collateral framework.

The Federal Reserve unveiled a more ambitious policy shift last year, saying it would pursue an average inflation rate of 2% over time. That means the Fed plans to allow inflation to rise above 2% to offset periods when inflation falls below that level.

A higher inflation target rate signals a longer period of easy money, which should provide additional stimulus to the economy.

The ECB's decision, after around 18 months of reflection, makes clear that undershooting its target is as bad as overshooting, meaning the ECB might react sooner to long periods of low inflation.

It "should make the ECB tighten [policy] later to ensure inflation really is back at target -- and not freak out from inflation barely hitting 2%, as has happened before under the asymmetric target," said Christian Odendahl, chief economist at the Centre for European Reform, a think tank.

The ECB has been criticized for increasing interest rates prematurely in 2008 and again in 2011, in an effort to control inflation, just before the eurozone collapsed into recession.

Unlike the Fed, though, the ECB won't actively aim to run inflation above target to make up for previous shortfalls.

In practice, the ECB's move "will make no major difference in our view as the majority of council members has probably been aiming for that [2% target] anyway," said Holger Schmieding, chief economist at Berenberg Bank.

"Trying to push inflation above 2% for a while through an even more aggressive stance is not required for the economic outlook, which is very positive anyway. And it could be political dynamite in countries such as Germany," said Mr. Schmieding.

The ECB has for years struggled to meet even its current target. Annual inflation in the eurozone averaged about 1.2% since the summer of 2008, down from about 2.1% in the previous nine years, according to Natixis.

The Bank of Japan in 2016 committed to overshooting its inflation target of 2%, but consumer price inflation in Japan has since languished below 2%.

ECB President Christine Lagarde launched the strategy review at the start of 2020, motivated by the sobering probability that central banks around the world would face greater difficulty than in the past to spur growth due to low levels of interest rates. It is the first revamp of the central bank's policy-setting framework since it approved a formal inflation goal of "below but close to 2%" in 2003, five years after the bank was established.

Write to Tom Fairless at tom.fairless@wsj.com

(END) Dow Jones Newswires

07-08-21 0735ET

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