The new ECB strategy: Draghi’s legacy
Change of strategy at the ECB, just a formality
The publication of the ECB's new strategy yesterday came as no surprise. The impact on markets has been minimal because it had been so clearly anticipated. But, even so, there are some interesting reflections for the future of asset classes.
It seems to be the result of a cultural change within the ECB. From its inception until the European debt financial crisis in 2009-2011, most analysts viewed the ECB as Bundesbank’s child. Admittedly with some more internal dissension, but mainly focused on avoiding any upward spiral of inflation, at any cost. In the last ten years, however, there has been a cultural shift led by Draghi towards a much looser concept of monetary policy. From a strictly macroeconomic point of view, it makes perfect sense. It has become clear that CPI inflation is now a very different phenomenon than it was in the 1980s and 1990s. In particular, it is more global, less persistent, with more downside risk and less controllable by central banks.
Financial stability becomes the primary goal
The controversial rate hike in 2011 and Draghi's commitment to "whatever it takes" in 2012 put the spotlight on financial stability. Until then it was a secondary objective, so much so that very few people knew it existed. Since then, it seems to be the main goal in practice, insofar as it can bring to the European economy more advantages than the struggle for stable inflation, although with certain risks in how it is translated into practice (in this regard, see our note "The seeming paradox of the ECB", issued on June 11th). In fact, the so-called unconventional tools (asset purchases, forward guidance…), although they have not succeeded in raising CPIs towards their target, have, to a certain extent, maintained financial stability as the ECB understands it (controlling yields). This guarantees a much looser monetary policy than would be the case if inflation were the primary objective.
Draghi's legacy is not limited to financial stability. The main change consisted in making the inflation target symmetrical at 2%. In other words, previously a target below that figure was sought, and now an upward and downward deviation is weighted equally. Draghi himself had proposed a symmetric inflation target at least in 2016 and 2019, in a context of deflation risk. Such risk is what justifies that, for him, downward deviations are undesirable. In practice, therefore, we have been for several years below the desired target, as we are right now, which also contributes to prolonging the current dovish policy. In this sense, moreover, there is a decoupling from the US Fed's policy. In fact, it would even make sense to move in the opposite direction (as we also pointed out in the above-mentioned note of June 11th).
On the other hand, other less well-known changes have been introduced. A metric for the cost of home ownership will be included in the CPI, similar to what is already a well stablished practice in the USA, Japan or Switzerland. The reasoning is that it is a fundamental cost for families that was only considered in the case of renting. But the problem is that, since housing is an asset, isolating the cost of the housing "service" is very difficult. In the US, it is measured by surveys, but in Europe, experimental practices have been carried out only by a statistical process of calculating the cost of buying and maintaining a home (without filtering out the cost of land). Several papers suggest that this methodology would increase the CPI by 2 or 3 tenths, although it would mean a break in the series, i.e., they would no longer be comparable with the past. In any case, its application will reduce the risk of too low CPIs, due to the downward resistance of these costs; but anyway, it will take several years, so we expect no impact in the short term.
More flexible (or maybe we should write “arbitrary”) monetary policy
In conclusion, in my opinion, the important thing about the ECB's new strategy is not the symmetry in the inflation target, but rather that, following Draghi's legacy, it turns the once extraordinary tools (asset purchases, future guidelines, etc.) into permanent ones, by making the financial stability objective primary. The fact is that these tools, applied for ten years, have not managed to raise inflation, but they have managed to maintain the financial stability of the Euro Zone (if we assume as such the fact of keeping sovereign yields artificially low). Taken together, and like last summer's revision of the Fed's strategy, it warrants a more dovish policy than the previous framework. And for markets it implies lower yield curves, a more depreciated euro, and more support for risky assets. In other words, more of the same recipe we have had so far. In fact, this strategy has been applied de facto for several years, as has the Fed's strategy.
Moreover, because of all this, the ECB becomes more involved in the fiscal policy of the EZ, as it becomes a key element in the financing of governments. This makes sense, insofar as the inflation target only seems achievable with fiscal or regulatory policies (but is it desirable…?). In addition, the new strategy also includes a document on climate change, which may make financing more difficult for companies that do not act in the "right" way in this respect..
Alberto Matellán, Chief Economist at MAPFRE Inversión