Inflation poses headache for new ECB chief economist Philip Lane

The European Central Bank's Philip Lane started his first day at work on Monday at a crucial moment for the euro zone as signs of economic weakness re-emerge and questions grow about the bank's ability to tackle them.

Mr Lane, the bank’s new chief economist, faces the immediate challenge of preparing for Thursday’s monetary policy meeting in Vilnius, where he will present updated forecasts – and could downgrade the outlook.

In the longer term, he must grapple with the question of whether the central bank should rip up its current doctrine to combat years of too-low inflation.

Mr Lane's predecessor, Peter Praet, cut growth and inflation projections in March, and some economists are concerned that conditions have worsened since then, a trend that could be exacerbated by the escalating US trade war.

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The economic gloom comes at a time when personnel changes at the top of the bank have triggered a debate about fresh policy measures and the scope for further stimulus.

On Thursday the ECB is expected to release details of how it will price its next auctions of cheap long-term loans and discuss whether changes in its interest rate policy are needed.

But with its president, Mario Draghi, set to depart in October, his potential successors are jostling for position by proffering alternative policy approaches.

“It is a difficult time for any central bank, especially with the trade war intensifying,” said Anatoli Annenkov, economist at Société Générale. “There is doubt about what the central bank can do.”

Academic rigour

Mr Lane, hitherto the governor of the Central Bank of Ireland, succeeds Mr Praet, who became a key ally of Mr Draghi and backed up the ECB president’s use of unconventional monetary policy to fight the euro-zone crisis.

A euro-zone rate-setter since becoming Ireland’s top central banker in 2015, the softly-spoken economist received his doctorate from Harvard and has developed a reputation for academic rigour during his time on the ECB governing council.

The inflation challenge Mr Lane faces as he begins his eight-year term is becoming more pressing: at 1.3 per cent, the five-year on five-year inflation swap rate – an important measure of market expectations – hovers way below the ECB’s target of below but close to 2 per cent.

“With inflation continuing to lack any convincing signs of an upward trend and downward risks increasing, there is a chance that the inflation projections are nudged lower [on Thursday],” said Ryan Djajasaputra, an economist at Investec. “Such a result could prompt the [ECB governing council] to question whether an adjustment to policy is required.”

Difficult moment

If inflation stays low, it will fall on Mr Lane’s shoulders to shape the bank’s intellectual response in an era where central banks are facing serious threats to their authority.

“This is a difficult moment for the euro zone – after a couple of years of strong growth, economic activity has disappointed and inflation continues to be stuck at a low level,” said Gian Maria Milesi-Ferretti, deputy research head at the IMF, who has worked with Lane for more than 20 years. “These are not easy waters to navigate, and require the ability to think outside the box. Having a person like Philip who remains open and willing to learn and experiment will be very important.”

Mr Lane has said in the past that the reason for inflation continuing to undershoot the bank’s target is that the region’s economy is still recovering from the crisis, and he remains confident that price pressures will eventually pick up as firms raise prices. But he is thought to share Mr Praet’s and Mr Draghi’s views that the bank could do more to spell out that it is just as serious about bringing inflation to the ECB’s self-imposed target of 2 per cent as it is about keeping price pressures below this level.

Two of the candidates to succeed Mr Draghi as ECB president this autumn, former Bank of Finland governor Erkki Liikanen and incumbent Olli Rehn, have both said the euro zone’s monetary guardian should be willing to tolerate a period where inflation is above 2 per cent. – Copyright The Financial Times Limited 2019/Bloomberg