Europe Central Bank Statement

Author: | Published: 19 Oct 2018
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We have set out three conditions that must be in place for our net asset purchases to end. We need to see the convergence of inflation towards our aim over the medium term; we need to have sufficient confidence that this convergence will be realised; and the inflation path needs to show resilience and be self-sustaining without additional net purchases.

Assessing these conditions is a forward-looking exercise, because the full effects of monetary policy are felt only after long lags. We have to rely on our projections, the probability distributions surrounding them, and the extent to which they are dependent on our own monetary policy actions.

In terms of convergence, the latest projections see headline inflation reaching 1.7% in each of the next three years. Inflation excluding food and energy – a simple measure of underlying price pressures – is expected to climb to even higher levels over the same horizon. These are the latest in a series of projections which foresee inflation converging to our aim over a policy-relevant medium-term horizon. Importantly, over the course of the past year, that convergence path has held firm, and the timing of when we expect to attain our objective does not appear to have receded further into the future.

Our confidence in the inflation path is also rising, on the basis of two indicators we have been using to assess the probability of inflation convergence.

The first is our own internal estimates of the distribution of future inflation outcomes. ECB staff have constructed a measure that combines the implied inflation distributions from a variety of sources – Eurosystem staff projections, model-based estimates, market-based measures of expectations and surveys such as the SPF. These sources are then weighted by their historical ability to accurately forecast inflation.

That aggregate probability distribution of two-year-ahead inflation expectations has evolved in three dimensions that provide confidence that inflation adjustment is sustainable. The mean of the distribution has increased, the dispersion of the distribution has narrowed, and the downward skew has declined.

Second, we have been monitoring a range of measures of underlying inflation, including model-based statistical measures such as what we refer to as the persistent and common component of inflation (PCCI) and exclusion-based methods such as inflation excluding food and energy.

Measures of underlying inflation typically provide some early information about the rate at which inflation will stabilise in the future, once all the noise that is affecting current observed headline measures has faded away. Though underlying inflation has not yet shown a clear upward trend, the improvement in wage growth, domestic producer prices and inflation expectations gives us more confidence that, as resource utilisation continues to tighten, underlying inflation will eventually begin to rise.

Finally, market pricing provides some comfort on the resilience of inflation to the anticipated gradual ending of asset purchases.

This is an excerpt from the Monetary policy in the euro area speech given by Mario Draghi, President of the ECB, at the ECB Forum on Central Banking, Sintra, June 19 2018. The full speech can be freely accessed at www.ecb.europa.eu.