Investment Institute
Viewpoint Chief Economist

A late Italian Strike?

  • 12 July 2021 (15 min read)

Key points

  • The European Central Bank’s (ECB) strategy review, seemingly aligning its official stance with Mario Draghi’s public views at the end of his tenure, provides the intellectual underpinning for prolonged stimulus at a time when the propagation of the Delta variant rekindles downside risks to the ongoing recovery. Still, ambiguity abounds.

While covid-related uncertainty is not going away, policy-makers’ resolve to provide stimulus as long as necessary remains crucial. Indeed, the latest news-flow on the pandemic front is concerning again. Even in the UK where the vaccination rate of the population is among the highest, tension on segments of the healthcare system is re-emerging as the Delta variant continues to propagate at a very fast clip.  Some restriction resumption is already underway in Portugal, parts of Spain and the Netherlands, even if we remain very far from the levels of stringency still seen only 2 months ago.

Beyond their current support, central banks can also provide reassurance to the market and to fiscal authorities by tweaking their long-term strategy. As widely expected, the ECB moved last week to a symmetric definition of price stability: 2% in the medium term, with deviations above and below “equally undesirable”. Inflation overshooting is now explicitly endorsed. This is putting the ECB’s official stance in line with what Mario Draghi had been saying repeatedly in the last 2 years of his tenure.

We are not sure however that Mario Draghi would be fully satisfied with the strategy review. There remains a gap between the Fed, for which overshooting should be “aimed for” in consideration with past sub-par inflation, and the ECB, for which it would be a mere possible outcome, while he might see “better taking into account” house prices as a concession to the hawks. The conclusions of the strategy review were adopted unanimously because in practice, the big and divisive decisions still lay ahead.

We also continue our exploration of the “technical factors” behind the surprising relapse in US long-term yields. The US Treasury’s cash management may have played a significant role recently: as its ballooning account at the New York Fed is being emptied, liquidity rises while debt issuance needs fall. While the level of the Treasury General Account is still above its historical average, debt issuance should re-start at a faster clip once the “debt ceiling” is extended again at the end of this month.

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