ECB unveils higher inflation goal that tolerates overshoot

FRANKFURT: The European Central Bank yesterday set a new inflation target and agreed to integrate climate change considerations into its monetary policy strategy, the first major overhaul of its goals and tools in almost two decades.

The central bank for the 19 countries that use the euro currency will in future take into account companies’ environmental credentials when considering whether an asset can qualify as a collateral or be purchased by the Frankfurt institution.

It will also begin carrying out “climate stress tests” to assess the Eurosystem’s risk exposure to climate change, as concerns grew over the accelerating warming of Earth.

“The Governing Council acknowledged that climate change has profound implications for price stability and, accordingly, it has committed to an ambitious climate-related action plan,” it said in a statement.

The sea change came after an 18-month strategic review — the first since 2003.

Key among things to go is the ECB’s old inflation target of “close to, but below” 2%, a goal that was agreed in 2003 when rapid price increases were a real concern.

Inflation in the euro zone has however stayed stubbornly low for years despite unprecedented economic stimulus from the ECB, keeping the target well out of reach and fuelling calls for a rethink.

The board yesteday agreed on a “2%” target, that will also allow prices to rise above that cap temporarily after a long period of undershooting the goal.

“The Governing Council considers that price stability is best maintained by aiming for a 2% inflation target over the medium term,” it said in a statement, adding that there might be a “transitory period in which inflation is moderately above target”.

Pursuing a less strict inflation target follows in the footsteps of the US Federal Reserve which last year pledged more leeway, allowing inflation to rise above 2% “for some time” before raising interest rates, to boost employment.

ECB chief Christine Lagarde, who was scheduled to give a press conference later yesterday, said in a statement that the “new strategy is a strong foundation that will guide us in the conduct of monetary policy in the years to come.”

Hinting at the new inflation target in September, she had said that the euro zone should have an inflation goal “that the public can easily understand” and is calculated in a way that better reflects people’s everyday lives.

Analysts at Capital Economics said the tweak to the inflation target was a “historic shift for the ECB”.

“Whereas the bank has until now always had among the most ‘hawkish’ mandates of all major central banks, this would bring it into line with the mainstream,” they said.

“As such, it would sound the deathknell for the Bundesbank tradition, which has always emphasised the risks of high inflation above all else.”