Lagarde makes case for aligning ECB's inflation strategy with US Fed

European Central Bank President Christine Lagarde set the scene on Wednesday for a change of strategy that could align the ECB with the USFederal Reserve, possibly including a commitment to let inflation overshoot after it has been low for too long.

Inflation in the euro zone has missed the ECB's target of "below but close to 2%" for more than seven years, despite increasingly aggressive stimulus from the central bank, which has pushed its main interest rate below zero and bought more than 3 trillion euros ($3.51 trillion) worth of assets.

In her first update on the ECB's current review of its strategy, Lagarde also raised the idea that the ECB might in future focus on achieving that elusive goal more quickly.

The ECB is widely expected to follow in the footsteps of the Fed, which said last month it would aim for inflation of 2% on average, so that periods when prices grow too slowly can be compensated for with faster increases at another time.

"If credible, such a strategy can strengthen the capacity of monetary policy to stabilise the economy when faced with the lower bound," Lagarde told an event in Frankfurt called 'The ECB and its Watchers'.

French central bank chief Francois Villeroy de Galhau added that the ECB's aim is already not too different from that of the US central bank and should produce similar results.

"Our inflation objective, being symmetric and medium-term -- if credibly, I stress credibly, symmetric and medium-term -- would probably achieve similar outcomes ex-post to flexible average inflation targeting," Villeroy said.

Unlike the Fed, which has a dual role of achieving maximum employment and stable prices, the ECB's sole goal is price stability over an unspecified "medium term".

But Lagarde called this mandate "hierarchical", arguing that a flexible definition of medium term allowed it to avoid tightening policy and "unnecessarily constricting jobs and growth" in case of a temporary shock.

On the other hand, the ECB's persistent failure to meet the inflation target could feed into inflation expectations and would therefore "call for a shorter policy horizon".

Both arguments would imply that the ECB needs to continue or even ramp up its aggressive stimulus policy as inflation is expected to lag its target for years to come.

Lagarde said the ECB needed to keep track of housing costs, which have risen in richer euro zone countries such as Germany, while also complementing its analysis with measures of core inflation and indicators of financial stability.

Speaking at the same event, German ECB policymaker Jens Weidmann seemed to pour cold water on too ambitious a review of its mission.

"We should also pay close attention to how we interpret our mandate," the Bundesbank president said. "The more widely we interpret our mandate, the greater the risk that we will become entangled with politics and overburden ourselves with too many tasks."

The review resumed this month after a six-month break due to the coronavirus pandemic and is expected to last a year, although updates on the new definition of the ECB's inflation objective could come much sooner.