The kremlinologists at Capital Economics have sifted the tea leaves on whether the Fed’s move might prompt copycat action in Britain or the eurozone.
British analyst Ruth Gregory reckons the Bank of England has plenty of reasons to stick with its simple 2 per cent target.
First, over the past two decades, Britain’s consumer price index growth has averaged 2.2 per cent, while in the US the average has been 1.8 per cent. The BoE has evidently had less difficulty getting the rate to 2 per cent and above, and inflation expectations are accordingly higher in Britain.
Second, the BoE can’t change its remit – that would be Chancellor Rishi Sunak’s call, and he wouldn’t rush into it: probably not before his next budget (due later this year), and perhaps not before the BoE’s strategy review next year.
Even if he was considering it, Sunak would be listening closely to the BoE’s advice. And Gregory reckons governor Andrew Bailey and his team might be wary of encouraging the Chancellor to change the target. What the BoE needs right now, she says, is rock-solid credibility and independence, and tinkering with its remit mightn’t be the best way of preserving that.
Across the Channel, the story is much the same. Just as new president Christine Lagarde came on board late last year, the ECB launched a strategic review of its objectives and operations.
The coronavirus pandemic has delayed this. It’s unlikely to wrap up until late next year, so there won’t be any change to the objective – which is inflation “below but close to 2 per cent over the medium term” – until then.
Capital Economics’ chief European economist, Andrew Kenningham, says it’s possible the ECB might shift to a straight 2 per cent target. But it might ponder whether there’s merit in switching the formulation from “over the medium term” to the Fed’s “on average over time”.
“The Fed’s announcement is probably a good guide to the direction of travel for the ECB too,” he says. “As for its impact, an average inflation target regime may lift expectations slightly, but we doubt that it would do much to raise the actual rate of inflation.”
He also suggests the ECB’s review will mull other significant changes. It might allow the policymakers to consider divergences in national inflation rates across the 19-member eurozone. Or it might look at taking on a broader suite of objectives, including full employment, balanced economic growth and protecting the environment, and perhaps also make explicit the aim of defending the very currency union itself.
In any case, it’s a racing certainty that not one of the Fed, ECB and BoE will raise interest rates any time soon.
In fact, the only question being asked in recent days about the ECB meeting this week is whether Lagarde and her team have any worries about the euro’s gains against the greenback, which could take a bite out of already sluggish European exports.
Signals have been mixed. ECB board member Isabel Schnabel told Reuters she wasn’t too worried about the exchange rate, particularly as a lower US dollar could fire up global trade – which could offset any specific drag on eurozone exports.
The bank’s chief economist, Philip Lane, though, said he was watching the exchange rate’s movements: “If there are forces moving the euro-dollar rate around, that feeds into our global and European forecasts, and that in turn does feed into our monetary policy setting.”
A weaker euro could tickle the inflation rate – the headline is below zero and the core rate is at a record low – although much of this is due to temporary factors like discounting in the tourism industry, summer sales and German VAT cuts.
The economic news has been discouraging, with retail sales and activity indicators both falling back from the June-July rebound. And the pandemic news isn’t great either, with case rates rising in some countries such as Spain.
So Lagarde will probably engage in some jawboning to set expectations for the next round of quantitative easing (buying eurozone governments’ bonds to stimulate economic activity), with plenty of firepower left in the €1.35 trillion ($2.2 trillion) Pandemic Emergency Purchase Program.
“Given the uncertain near-term outlook and the flexibility that the PEPP offers, we think the ECB doesn’t have much to gain from adding stimulus now, which a strong dose of rhetoric couldn’t achieve,” says Oxford Economics analyst Oliver Rakau.
“Look out for Lagarde’s first attempt to talk up easing options in order to limit the euro’s rise.”