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European Central Bank Hiked is Inflation

The European Central Bank sets a new inflation target and its possible effects on monetary policy will be the key topic of this week’s meeting in Frankfurt. The hopes are high that the euro zone’s central bank will come up with a dovish surprise as President Christine Lagarde keeps stressing the need for a forceful policy response to avoid a de-anchoring of inflation expectations.

Lagarde said that they recognize very specifically that the proximity to the effective lower bound requires forceful or persistent monetary policy action. The European Central Bank hiked its inflation target from below but close to 2% to a symmetric 2% target over the medium term, which means that both overshooting and undershooting is allowed but not desirable.

The Federal Reserve in the United States announced that it would allow inflation to run hotter than normal as a way to boost the labor market and economic recovery. The central bank is less likely to increase interest rates. While some expect more than just tweaks in the ECB’s forward guidance this week, others expect a real sea change to come later this year once there is clarity about the region’s economic trajectory and the evolution of the coronavirus pandemic.

Anatoli Annenkov of Societe Generale said that the key message could thus be that there is no rush to signal tighter policy, even at the September/October meetings. We expect a better understanding of the possible end of the crisis phase of the pandemic late this year, suggesting that the key decisions on PEPP may only come then.European Central Bank put forward an emergency bond-buying program in March of 2020 to deal with the economic shock from the pandemic. This program, known as the PEPP, is currently set to last until March 2022 and total up to $2.2 trillion.

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