ECB Quick Analysis: Three dovish changes hit EUR/USD, more could be in store

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  • The European Central Bank will allow for a temporary overshoot of inflation. 
  • No tightening is on the cards before the ECB forecasts short-term 2% price rises.
  • The bank will also consider core inflation, another material shift. 

Promises made, promises kept – European Central Bank President Christine Lagarde has delivered a dovish policy shift, exceeding market expectations and defying hawkish members. That should keep EUR/USD depressed even if the dollar remains on the back foot.

Here are the three major changes:

1) Temporary overshoot of inflation

This may also imply a transitory period in which inflation is moderately above target

This sentence in the ECB’s statement is hard to swallow for hawks on the Governing Council, especially the German ones. The bank is officially allowing inflation to exceed the 2% target. 

While the ECB’s strategic review already moved toward a symmetric inflation target of 2%, adding this line to its immediate policy rather than the high-level strategy is a material change. Allowing an overshoot in price rises means lower interest rates – and more bond-buying – for longer. 

2) The white in inflation eyes

While the Fed wants to see inflation in the rearview mirror before considering any action, the ECB has a more modest target – at least forecasting that price rises hit that target in the short term. Staff forecasts have consistently projected sub-2% inflation for all timeframes. Here are the bank’s words, emphasis added:

the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon

Moreover, it not only wants to forecast its target in the near future but wants projections for the remainder of the horizon – three years – to consist of accelerated price rises. That is similar to the Fed’s “sustainable” target. Without these two conditions, rates will be glued to zero – another euro-negative move.

3) Core counts

While the strategic review left the headline Consumer Price Index (CPI) as the preferred metric – contrary to the Fed’s focus on core prices – the ECB is taking changes in non-volatile components into consideration. 

judges that realised progress in underlying inflation is sufficiently advanced

After recovering from the pandemic lows, Core CPI has hit 0.9% YoY in June and nearing 2% seems like a pipedream. 


The ECB delivered a dovish shift that should keep interest rates depressed for even longer than expected. The initial falls in EUR/USD could be only the beginning.