The U.S. Federal Reserve and the ECB: intentions do not match up with actions

Monetary policy is set to become more restrictive. This appears to be the aim of the U.S. Federal Reserve and the ECB. The ECB is likely to announce a reduction of its bond purchases shortly, while the Fed will reduce its balance sheet and, where necessary, introduce further key interest rate rises. Although these measures are no doubt expected by market players and are reflected in what a number of central bankers have been saying, both the Fed and the ECB appear to lack a clear communication strategy. They have become accustomed to highly embellishing the risks for the economy. For example, the latest report published by the ECB highlights the risks of a possible overshooting of the euro on the foreign exchange market far more markedly than in the past. A stronger euro might have a negative impact on financing conditions in the economy. The subject of inflation was also discussed thoroughly at the latest meeting of European monetary policy makers, who concluded that there were no convincing signs as yet that inflation would gather momentum in the coming months. In addition, the risks for the global economy were said to be on a downward curve. The central bankers at the Fed were similarly pessimistic at their monetary policy meeting on 25/26 July. The minutes of the most recent FOMC session indicate the central bankers’ increasing anxiety about the decline of inflation. There is a danger that inflation might remain below the Federal Reserve target level for a long time. All things considered, this is actually not in line with the expectation of intending to follow a less expansive course in the near future.

So will the risks indicated, particularly with respect to the inflation trend, deter monetary policy makers from making monetary policy less expansive? In essence, inflation rates have remained below central bank target levels for several years now. In light of this, it can be assumed that there actually will be a departure from ultra-relaxed monetary policy. Willingness to change monetary policy seems to predominate in spite of the low rate of inflation. Even though the ECB is currently highlighting the weak rate of inflation, Draghi is likely to announce a change in bond purchasing policy in autumn, while the Fed will pursue a reduction of its balance sheet. However, at this point in time, inflation will still be far below the ECB and Fed target level, which actually constitutes a contradiction. The current, very intensive discussions on the risks tend to the conclusion that the monetary authorities are rather uncertain, but very much hope that what they have planned will not negatively affect the financial markets. However, they will not be able to achieve this with the current uncertainties in their communication strategy.

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