Why the Fed will taper on the oil shock while others won’t

Deutsche looks at the role of oil in central bank thinking:

The financial world is trying to work out what the implications are for the energy price shocks we are seeing and whether central banks should tighten policy as a result or keep policy loose to reflect possible demand destruction that it might eventually bring. Indeed yesterday ECB President Lagarde warned that the “key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium-term”.

However, this has not been how they traditionally respond to big energy moves. Today’s CoTD (with a hat tip to DB’s Francis Yared) shows that since the ECB came into being they’ve tended to consistently tighten into rising oil prices (green on the graph) and loosen when they notably fall (red). The exception was in March/June this year when they loosened further by increasing the pace of the PEPP. So it’s interesting that in a world where central banks and markets tend to focus on core inflation rather than headline, the ECB’s monetary policy has been very linked to the ebb and flow of oil prices over the last 20 plus years.

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