Anti-Inflation Credibility Examined

The common narrative in the market is that the ECB inherited the German anti-inflation resolve. The ECB has a formal inflation target unlike the Fed. As the euro zone as a whole recovered, the ECB has gradually unwound many of their extraordinary liquidity facilities. It is expected to signal intentions to return to only weekly and monthly liquidity provisions next week. It is also expected to raise its inflation forecast. Given the recent rhetoric, many expect the ECB to in effect adopt a tightening bias, within the framework in which it does not pre-commit.

The historic record of the ECB more nuanced. Of the past 11 years, CPI in the euro zone has surpassed the 2% target 6 times. Twice when inflation came in below the 2% level, the euro zone was in a recession. Over the past 11 years, euro zone CPI averaged 2.1% annually. While the CPI baskets vary, it is interesting to note in comparison the US CPI has averaged 2.4% over the past 11 years. Slightly higher, but arguably not significantly so.

There are two follow up points. First, look at inflation excluding food and energy. Core euro zone inflation has averaged 1.65% over the past 11 years, while core US CPI has averaged just less than 0.9%. Second, not that one necessarily has to accept a trade off between growth and inflation (see Phillips Curve), but it is interesting to note that the US has delivered stronger growth than the euro zone on average during this period. According to IMF, on a year-over-year basis, the US economy has expanded on average 2.1% while the euro zone growth has been 1.5%.