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ECB Inflation Performance: A Review
• The eurozone inflation broke above the 2.0%
threshold in December. More importantly,
average eurozone inflation since January 1999
rose from 1.98% in November to 2.01% in
December.
• Other indicators show that inflation remains
subdued and below headline HICP, the measure
the ECB has chosen to target. This implies the
ECB has chosen the most demanding target.
• The latest inflation figure has not altered
ECB policy, but the language was toughened.
Jean-Claude Trichet revisited the wording of the
ECB achievement and that of the policy outlook.
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Base
98=100
Chart 1: HICP vs. Ceiling
Ceiling 2%/year
Actual HICP
(SA by BNP Paribas)
96
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Source: Eurostat, Reuters EcoWin Pro, BNP Paribas
Chart 2: HICP Inflation
The 2.2% flash estimate for eurozone inflation in
December was described in the media as the first
time inflation has exceeded the ECB’s target for more
than two years. The reality and the potential
consequences for ECB policy are more subtle.
What is the ECB’s true target?
As Jean-Claude Trichet usually puts it, the ECB’s
inflation goal is ‘below 2%, but close to 2%, over the
medium term’. This time horizon should not be
ignored. The cumulative average inflation rate since
January 1999 had been above the 2% ‘ceiling’ for a
long time by the end of the tightening cycle in July
2008 but the ECB had nonetheless refrained from
putting in place a restrictive monetary policy.
Mr Trichet recently insisted that, since the start of
monetary union, average inflation had been below
2%. He added that he felt "moved" by the EU
Parliament applause when he said that average
inflation was 1.97%. With the December print, the
average has gone to 2.01%...too bad!
Will that trigger quick policy action? This is unlikely.
When the ECB governing council decided in June
2008 to hike in July, it had at its fingertips the May
inflation estimate. This stood at 3.7% y/y, compared
with a 4% refi rate. This pushed the average inflation
rate from January 1999 as high as 2.22%. That rate
hike is often viewed in retrospect as a policy mistake,
but not within the ECB.
What do other inflation indicators say?
The ECB focuses on the headline HICP rather than
the ex-food and energy index; the Fed, for example,
favours the core PCE deflator. Over the short run,
4.0 Headline HICP (% y/y)
3.0
2.0
1.0
0.0
-1.0
2.0
1.0
0.0
-1.0
-2.0
Core HICP (% y/y)
99 00 01 02 03 04 05 06 07 08 09 10 11
99 00 01 02 03 04 05 06 07 08 09 10 11
Source: Eurostat, Reuters EcoWin Pro
Headline - Core (y/y)
Lagged 1 year
Core Inflation y/y Change
ignoring highly volatile factors can make sense.
However, over the medium term, all elements need to
be included in the index that the central bank targets
(especially vital elements such as food and energy).
Experience also shows that headline inflation tends to
lead core inflation (Chart 2). Nevertheless, core
inflation remains less volatile.
Using one measure rather than the other does make
a difference. In December, average inflation since
January 1999 was 2.01% while average core inflation
was 1.55%. This gap highlights that the main sources
of inflation have been food and energy, items over
which ECB interest rate policy has less influence.
As noted above, the Fed prefers to look at the PCE
deflator, a broader measure of inflation. However, the
Fed favours the less volatile ex-food and energy
definition of the deflator. Although the ECB has not
gone down this route, looking at the eurozone PCE
deflator would also make a lot of sense. By definition,
this index covers all goods and services consumed by
Dominique Barbet 20 January 2011
Market Mover
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