ECB should make clear its tolerance for overshooting inflation

PARIS: The European Central Bank should spell out its tolerance for overshooting its inflation target, ECB policymaker Francois Villeroy de Galhau said on Tuesday.

The ECB has seen euro area inflation fall short of its near 2% target for eight years and expects to miss the target for years as the bloc emerges from the coronavirus crisis.

Villeroy, who is also governor of the French central bank, said that the objective had to be understood as a medium-term target rather than a ceiling and inflation could be tolerated above 2% "for some time".

With inflation still well below the target despite a recent pick-up whose causes he described as temporary, Villeroy said the time has not arrived to exit the ECB's exceptional bond buys that have been underway through the crisis and when the time comes, there would not be an abrupt tightening of policy.

Nonetheless, he said there was room to improve guidance the ECB gives the market about how it aims to pursue its inflation target.

"Rather than flexible average inflation targeting, which leaves many questions unanswered, my preferred option would be the use of a strengthened and non-linear forward guidance, mentioning explicitly our tolerance for inflation overshooting, with reference to past inflation shortfalls," Villeroy said at an online event hosted by the Peterson Institute for International Economics.

Villeroy also said the ECB should not tie itself down with a quantitative definition of what it means by its commitment to provide "favourable financing conditions," as market analysts sometimes suggest.

"We will make informed judgements rather than apply predetermined rules. Not acting automatically does not prevent responding effectively - quite the contrary," he said.