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ECB chief economist shifts inflation stance to signal policy ‘normalisation’

Philip Lane, chief economist of the European Central Bank, has shifted his position on eurozone inflation by saying it looks unlikely to drop below its 2 per cent target in the next two years.

“Inflation is expected to settle around 2 per cent,” Lane said on Thursday, citing higher expectations of investors, analysts and consumers, and structural changes in the economy. “In terms of asset purchases it is a different path than if it was going to spend a period below 2 per cent.” 

The shift in Lane’s position matters because the expected level of inflation in 2023 and 2024 is the main factor governing whether the ECB will accelerate plans for removing the vast stimulus it has provided via bond purchases and negative interest rates during the pandemic.

His comments mark a change from only three weeks ago when Lane said inflation was equally likely to drop below the ECB’s target and to stabilise at that level in the medium term. Since then, record eurozone inflation of 5.1 per cent prompted its president Christine Lagarde to say inflation risks were “tilted to the upside” while refusing to rule out raising rates this year.

Lane is one of the most important influences over ECB monetary policy and his comments underline how a consensus is forming on its governing council about the need to withdraw its stimulus faster than planned when it meets in three weeks’ time.

If policymakers judge that inflation is on track to hit its target over the next two years it clears a path for them to end net purchases in the ECB’s €4.8tn bond-buying programme and to prepare the ground for raising interest rates for the first time since 2011.

Lane told a webinar organised by market news and data provider MNI that he did not want to prejudge next month’s meeting. He said the change in inflation expectations was not “staggeringly huge” so any change in policy would still be gradual.

He also drew a distinction between a likely “normalisation of policy” — widely interpreted as ending asset purchases and raising its deposit rate to zero — and a more drastic “monetary tightening” to push up financing costs and slow growth that would be required if inflation was likely to remain well above its target for several years. “That is not what we see in front of us,” he said.

“Impressive to see how fast a consensus at the ECB could be built on normalisation,” Carsten Brzeski, head of macro research at ING, said on Twitter. “Only unsolved questions are: when to hike the deposit rate and what to do when once the deposit rate is back at zero.”

The ECB in December forecasted inflation would fall back below its 2 per cent target by the fourth quarter of this year and remain at 1.8 per cent for the next two years, justifying continued stimulus. But it is widely expected to raise these forecasts next month.

Lane said: “There are several factors indicating that the excessively low-inflation environment that prevailed from 2014 to 2019 — a period over which inflation averaged just 0.9 per cent — might not re-emerge even after the pandemic cycle is over.”

He said the factors lifting inflation expectations included the ECB’s massive fiscal and monetary stimulus in response to the pandemic and last year’s simplification of its inflation target from “below but close to 2 per cent”. 

Although Lane said digitalisation could reduce prices, he also cited structural shifts that may increase them including higher wages in emerging markets, China’s move from focusing on exports to domestic demand, a push to lower carbon emissions and ageing populations.

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