Global Daily – Is the ECB set for an over-shoot strategy?

by: Nick Kounis , Bill Diviney

ECB View: 2% target seems likely, average inflation strategy still in the balance – ECB President Christine Lagarde spoke this morning on the subject of the ECB’s monetary policy strategy review at the ECB and Its Watchers conference. We covered her speech in more detail earlier today in our ECB Watch note. Our main takeaway from her comments is that price stability in the future will no longer be defined as ‘below, but close to, 2%’ but rather a symmetric target of 2%. This would represent an increase of the inflation target from 1.7-1.9% currently and get rid of the inherent asymmetry of the ‘below, but close to’ language. However, what really made news headlines was that the ECB was considering a make-up or average inflation strategy, where it aims to offset past undershoots of inflation with future overshoots (or vice versa in circumstances that differ from those of today). So is the ECB heading in this direction? A careful reading of her comments suggests that the choice for such a framework is still very much in the balance. Ms. Lagarde underlined the positives of such a move, noting that  ‘such a strategy can strengthen the capacity of monetary policy to stabilise the economy when faced with the lower bound. This is because the promise of inflation overshooting raises inflation expectations and therefore lowers real interest rates’. However she went on to say that ‘make-up strategies may be less successful when people are not perfectly rational in their decisions – which is probably a good approximation of the reality we face’. The latter comments suggest that the ECB has some doubts. This may also reflect differing opinions within the Governing Council. While Francois Villeroy and Olli Rehn for instance appear to be supporters of such a move, other officials seem to be taking a more conservative approach. (Nick Kounis)

US Macro: Preview of the elections – With a little over one month to go until the presidential election, polls continue to suggest a close race, but Biden has a stronger edge over Trump than Clinton did in all battleground states. Demographic changes mean there is even a chance that some traditional Republican stronghold states could flip Democrat. Mass voting by post means delays to the result – and potentially disputes – are much more likely than in recent elections. Disputes raise the possibility of unrest, and polling suggests Democrat voters are more likely to react with anger to a Trump win than Republican voters to a Biden win. Disputes and unrest would be a negative for markets. Congressional elections also take place on 3 November, and could be just as crucial as the presidential election itself. Polls suggest Democrats will retain control of the House, and could gain control of the Senate. This raises the prospect of dramatic policy changes under an ‘all blue’ executive. However, we see the most likely scenario to be Biden winning the presidency, Democrats retaining control of the House, and Republicans retaining control of the Senate. This means Democrats would have to compromise with Republicans to get legislation passed. In any election scenario, ‘lower for longer’ interest rates means the path of least resistance is a continued dramatic rise in government debt. A Biden-led government would spend much more, while a Trump-led government would cut income taxes. We also expect US-China trade decoupling to continue in all scenarios, though a Biden presidency would repair relations with traditional allies and take a more multilateral approach to trade disputes. Please see our note US Watch – Likely Democrat win in November, but could be a bumpy ride for more. (Bill Diviney)