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ECB launches review, keeps policy on hold

The European Central Bank launched a broad review of its policy today that is likely to see new President Christine Lagarde redefine the ECB’s main goal and how to achieve it. 

The European Central Bank has fallen short of its inflation target of just under 2% for years, even after Lagarde’s predecessor, Mario Draghi, launched increasingly aggressive stimulus measures. 

Christine Lagarde told a news conference the review was likely to take about a year but hinted it might take longer. “It is over when it is over,” she said. 

She declined to comment on what changes she might favour to the inflation target, but promised: “We will not leave any stone unturned and how we measure inflation is clearly something we need to look at.” 

The review will also look closely at how the bank can incorporate the economic impact of climate change into its policy models. 

The ECB will adhere to its current strategy until a new one is adopted, Lagarde said today. 

ECB rate-setters did not make any policy change today, simply standing by their pledge to keep buying bonds and, if needed, cut interest rates until price growth in the euro zone heads back to their goal. 

The ECB said its rate on bank overnight deposits, which is currently its primary interest rate tool, remains at a record low of -0.50%.  

The main refinancing rate, which determines the cost of credit in the economy, remained unchanged at 0% while the rate on the marginal lending facility – the emergency overnight borrowing rate for banks – stayed at 0.25%. 

The euro dipped slightly after the ECB rate announcement but hardly budged during Lagarde’s press conference. It was last down 0.1% at $1.1084.

While the review takes place, the ECB is expected to leave its monetary policy on hold, as it did today. 

That would leave it adding €20 billion worth of bonds to its €2.6 trillion portfolio every month and charging banks 0.5% on their idle cash for most of the year. 

“The Governing Council expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2%,” the ECB said. 

Ms Lagarde told the news conference that risks to growth in the euro zone remained tilted to the downside, but this bias had become less pronounced as uncertainty around international trade recedes. 

Euro zone data has improved recently, leading economists to believe the export-focused economy has weathered the storms of the global trade war. 

A trade deal between the US and China, and the prospect of an orderly Brexit are also lessening the two main risks the ECB had said were clouding the horizon. 

Changing the ECB’s formulation of price stability – currently defined as an annual inflation rate below, but close to, 2% over the medium term – will be the focal point of the review. 

The ECB could signal its commitment to boosting inflation by raising the goal to 2% and spelling out that it will take any undershooting just as seriously as an overshoot. 

“Our inflation target must be symmetric. If the central target is seen as a ceiling, we have less a chance of meeting it,” ECB policymaker Francois Villeroy de Galhau said recently. 

But policy hawks on the Governing Council, who have long called for the ECB’s money taps to be shut off, will not go down without a fight. 

Some of them favour creating a tolerance band around 2%, which would reduce pressure on the ECB to act, while others would leave the target unchanged or even cut it. 

Rate-setters will also debate the pros and cons of their tools, such as sub-zero rates and massive bond purchases, which have been credited with staving off the threat of deflation but at the cost of an unprecedented rise in house and bond prices. 

The ECB regularly lauds those instruments, recently estimating that without them, the euro zone economy would have been 2.7 percentage points smaller at the end of 2018. 

But minutes of the December meeting show growing discomfort about their side effects. 

That led to calls by some policymakers to give housing costs greater weight in inflation calculations and take into account households’ perceptions of price growth, which is generally higher than official figures.

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