Market Overview

The European central bank (ECB) made an unexpected move in its monetary policy by changing its inflation target from the previous “below, but close to, 2% over the medium term” to “2% over the medium-term with a ’symmetric’ aim”. The new approach of the ECB is clearer as the Governing Council of the ECB is now considering negative and positive deviations from this target due to the fact that now they are equally undesirable.

However, this statement eliminates “any possible ambiguity and resolutely conveys that 2% is not a ceiling” as the President of the ECB Christine Lagarde said. The Harmonised Index of Consumer Prices (HICP) remains the appropriate measure for assessing price stability, but it will also would be complemented with initial estimates of the cost of owner-occupied housing to supplement its set of broader inflation measures.

But this is not seen to be just talk. It means that the ECB in not going to consider monetary tightening if the inflation overshoots the 2% target. The ECB has been dreaming of such an inflation level since 2019 and it was reached only in May 2021.

So, will the ECB just follow the U.S. Federal Reserve (the Fed), or won’t it? Generally, the ECB indicates that overshooting the 2% inflation target would not immediately lead to a monetary tightening and it would probably be continued until the European economy fully recovers from the pandemic. So, any price spikes above this level could be considered by the ECB as “variant of the normal”. The new strategy allows the ECB to pursue an “especially forceful response” during adverse shocks, according to Mrs. Lagarde. And this is a different approach from the one take by the Fed as the ECB is clearly delivering a message that it would not follow U.S. policymakers in possible early monetary tightening. So, eventually the ECB may have a different monetary policy with continuous monetary stimulus, while the Fed would probably implement its tightening.

Such an approach changes the perspectives towards and the positioning of the Euro. This may completely change a clear upside trend that started back in the spring of 2020 with the recent expectation of the strengthening of the single European currency to the 1.25 level against the Greenback. So, a major reversal of the Euro may take place with the first target for the Euro at 1.1700-1.1750. If these targets are met, the Euro may go even deeper towards the 1.1600 area.

In the alternative scenario the Euro needs to overshot the resistance level of 1.19800 to keep up with an existing upside trend. Such a scenario could be possible in the current pandemic-exacerbate situation, but it is less likely.

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