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After a series of meetings for which expectations were low, the ECB meeting of 22 July seemed more promising. With another shake-up to its initial timetable, the Frankfurt institution raised expectations by unveiling the conclusions of its strategy review a few days earlier. This exercise consisted of a thorough analysis of the framework for its mandate and toolkit.
Christine Lagarde’s press conference took a new form, as the ECB showed its willingness to reach the widest possible audience, and there were also several remarkable changes to fundamentals.
As regards the form, the ECB President clarified the new inflation target, which she defined as having “three legs”. The first leg is the target itself. Gone is the convoluted “below but close to two percent” and in comes the “symmetric” 2% inflation target. The second and third legs relate to the measure itself: the much quoted 2% is a target over the ECB’s forecasting horizon, i.e., the ongoing year and the following two years. Lastly, the current economic situation is also taken into account in the analysis.
In contrast, with regards to fundamentals, two revolutions are in the pipeline.
New component for measuring price development
The first concerns the inflation measure. This is likely to evolve to take into account owner-occupied housing costs using a fictitious rent indicator. Bearing in mind that residential real estate prices have risen by an average of 3.6% per annum since 2015 within Europe, and that this item represents around 12% of household spending, we estimate that its retrospective inclusion in inflation would have added close to 0.4% per annum. And with core inflation struggling to reach 1% during the period, this is far from negligible. In Europe, around seven out of ten households own their home, meaning that the inclusion of this element will provide a much better indicator of price rises actually experienced by households. Once it has been included, expenses related to housing will represent the largest item in the inflation calculation, undoubtedly accounting for over 20%.
Green change in sight for balance sheet management
The second revolution could be in the colour of the ECB’s asset purchases. Although the issue was barely mentioned at the press conference, the inclusion of climate-related matters as part of the monetary policy framework will result in a radical transformation to how the ECB manages its balance sheet. Indeed, the ECB published the breakdown of its portfolio of corporate bonds by segment during July. This revealed a brown-tinted portfolio with positions in energy, transport, utilities and polluting industries: the highest carbon emitters are much more broadly represented than in the market. The green revolution is still a long way off, but there are quiet preparations under way. Whilst the Frankfurt institution looks to be shuffling forward, a deep transformation is beginning to take shape.
By Olivier de Berranger, CIO, LFDE