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FRANKFURT — Christine Lagarde’s first major deliverable as leader of the European Central Bank showed she’s good at papering over the cracks.
Almost two years into her presidency, Lagarde delivered a profound overhaul of Europe’s most powerful financial institution ahead of time and with the full backing of all Governing Council members — its first strategy review in nearly two decades and the most substantial exercise since the introduction of the common currency.
But her apparent victory in getting unanimous support for the strategy review masks a rift over what it actually means for the brass tacks of setting monetary policy.
In interviews with POLITICO after Thursday’s announcement, governors from Portugal and Ireland illuminated the diversity of opinions when it comes to translating the strategy into policy decisions.
“All of us have views and some of us have different views,” said Governing Council member Gabriel Makhlouf.
As the eurozone fights its way out of the deepest recession since World War II, Lagarde’s ability to rally policymakers behind a common strategy is yet to be put to the test.
She doesn’t have long to wait: In just over a week, the bank’s policymakers will debate whether to update the ECB’s forward guidance, setting out its expectations on the state of the economy and the likely future course of monetary policy.
Lagarde is already bracing for turbulence.
“It will be tested every six weeks from now on,” she said of the forward guidance in an interview with the Financial Times published Tuesday. “But I’m not under the illusion that every six weeks we will have unanimous consent and universal acceptance because there will be some variations, some slightly different positioning. And that is fine.”
The review had been widely expected to come only after the summer, especially after policymakers had gone public with conflicting views on the key issues of where the new strategy should take the central bank’s price stability goal.
One of the ECB’s top staff members said that keeping everyone on board throughout the process was a priority for the president. Lagarde herself underlined the importance she attaches to getting full support at her post-announcement press conference.
“This unanimity gives added credibility to our commitment to achieving our target of 2 percent inflation,” she said Thursday.
Since joining the ECB, the 65-year-old Frenchwoman has worked to overcome the divisive atmosphere on the Governing Council that her predecessor Mario Draghi left behind. Draghi had the habit of indicating decisions ahead of time to the dismay of many colleagues, in particular the fiscal hawks favoring tighter monetary policy.
Governors spoken to for this article had only praise for Lagarde’s leadership. “Her style is to arrive at a consensus. And that is important,” said Makhlouf, governor of Ireland's central bank.
Underlining that a diversity of views is a positive element of discussions, Makhlouf lauded Lagarde for her style in moderating agreements. She “invites us to speak, encourages us to get on with it, if we're taking too long to speak,” he said. “Certainly her style is different from her predecessors.”
Mário Centeno, another Governing Council member, said that Lagarde’s role in ensuring a constructive debate and striking a deal was “decisive.”
“I was for two and a half years president of the Eurogroup,” the Portuguese governor said. “I know all about red lines, pink lines, green lines. I can tell you that the debate around this table, it was smooth and constructive. Differences could be identified very easily, but they never interfered with this mindset of consensus-building.”
But making unanimity a priority may have come at the cost of substance and clarity.
Policymakers agreed to change the inflation target from below but close to 2 percent currently to a 2 percent target. The ECB also recognized that anchoring inflation expectations at 2 percent when interest rates have hit rock bottom may imply “a transitory period in which inflation is moderately above target.”
However, there is a broad range of interpretations on how the reference to an inflation overshoot may or may not change the bank’s reaction function.
Lagarde herself, after repeatedly promising the ECB would communicate more clearly on policy decisions, failed to shed any light on what the vague reference means. When asked about it at Thursday’s press conference, she simply repeated the agreed line without any information on how long or desirable any target overshoot might be.
That left space for other policymakers to offer their spin.
Finnish governor Olli Rehn, who had publicly lobbied for a switch to U.S. Federal Reserve-style average inflation targeting — under which policymakers allow inflation to overshoot the target to make up for previous periods of undershooting — saw elements of that in the ECB’s agreement.
“I was indeed with my heart and soul behind the decision,” he said of the central bank’s change, adding: “Overall, the motivation of the strategy review and the analysis provided are not that far apart in the case of Fed and the ECB.”
“My interpretation of the strategy review is that if similar economic shocks were hitting both the United States and the euro area, the monetary policy reaction functions on both sides of the Atlantic would not be that far apart,” Rehn added.
But Makhlouf pointed to the differences. “We're not doing what the Fed is doing. We are not doing average inflation targeting. We're not doing makeup strategies,” he said. “What we are recognizing is, especially when you're operating at the lower bound [of inflation rates], that the sort of action you may take may lead to transitory overshooting. We use the word transitory which is even less than the word temporary. It's almost incidental.”
Unsurprisingly, Bundesbank boss Jens Weidmann shared this more hawkish reading of the new strategy. “We do not make our monetary policy contingent on targets not met in the past,” he said. “We are not striving for either lower or higher rates.”
In perhaps the most candid evaluation, Bank of France Governor François Villeroy de Galhau conceded that policymakers had no firm definition of what a transitory overshoot may look like. “We didn’t discuss any duration; we didn’t discuss any numbers. It’s all about the context,” he said in an interview with Boursorama.
Or as Rehn put it: “There is still plenty of room for discretion, as there should be, as monetary policy is still as much an art as it is a science.”
Rifts are back
The unanimous agreement over the review language was sealed at the first in-person meeting of the Governing Council since the start of the pandemic, in the hills just outside Frankfurt.
It remains to be seen if the gathering helps set a constructive tone for the challenging discussions ahead, or if disagreements will spill into next Thursday’s discussions on the forward guidance.
One of the key points of contention is over the Asset Purchase Programme (APP), which some policymakers want to extend into at least 2023. Some also favor decoupling the APP from the bank’s pledge to keep rates low.
“I think the forward guidance needs to be adapted to the new strategy. I will contribute to a compromise on that,” Centeno said. “I understand that we gain from disentangling the APP and interest rates in the forward guidance. In the current format, one of the decisions is anticipating the other in a way that I don't think is effective.”
Others disagree. “I, personally, I would not be comfortable with what you just described on APP,” Makhlouf said when quizzed on the proposal. “I'm not sure that limiting ourselves to a specific timescale is helpful. I think we need to have flexibility. And certainly, in the world we are living in, the more flexibility we are going to have the better.”
The future of the bank’s coronavirus emergency support program PEPP is also very much up for debate, after the ECB pledged it will continue such purchases until at least March 2022.
Some policymakers already saw scope to reduce monthly bond purchasing volumes from the current €80 billion at the June meeting, even though most backed chief economist Philip Lane’s suggestion to keep them at current levels.
ING economist Carsten Bzerski said such an open challenge can only mean that there is growing opposition to the current course. “The rift between hawks and doves, last seen in mid-2019, seems to be back,” he said in reaction to the minutes from the June gathering.
“Against the background of strategy review presentation, the 22 July meeting will be extremely interesting,” Bzerski predicted.
If she wants to continue her record of unanimous decisions, Lagarde may have to bring her much-lauded negotiation skills to the next level.
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