Monetary policy decisions

On 14 December 2023, the ECB Governing Council decided to maintain the three key ECB interest rates. Therefore, the interest rate on the main refinancing operations, the interest rate on the marginal lending facility, and the deposit facility will remain at 4.50%, 4.75%, and 4.00% respectively.
Although inflation has reduced recently, it is likely to increase temporarily in the near term. Yet according to the latest Eurosystem staff projections for the euro area, inflation is expected to decline gradually throughout the next year, approaching the Governing Council’s target of 2% in 2025. For 2023, staff predict headline inflation will average 5.4%, with further decreases to 2.7% in 2024, 2.1% in 2025, and 1.9% in 2026 – a downward revision compared to the previous forecast.
Underlying inflation has eased, but domestic price pressures remain high, primarily owing to strong growth in unit labour costs. Inflation excluding energy and food is expected to average 5.0% in 2023, dropping to 2.7% in 2024, and 2.1% in 2025 and 2026. The past interest rate increases continue to influence the economy, contributing to the current depressed demand and lowering inflation. Economic growth is predicted to remain modest in the short term, but will recover due to rising real incomes and improved foreign demand. Growth is expected to rise from an average of 0.6% in 2023 to 0.8% in 2024 and 1.5% in 2025 and 2026.
The Governing Council remains determined to ensure that inflation returns to the 2% medium-term target in a timely manner. The current key ECB interest rates are seen as being at levels that, sustained for a sufficient duration, will significantly contribute to this goal. Future decisions will ensure that policy rates remain set at appropriately restrictive levels for as long as necessary.
The Eurosystem’s balance sheet will be normalised, with the Governing Council deciding to advance it. Full reinvestment of principal payments from maturing securities purchased under the PEPP during the first half of 2024 will continue. Over the second half of that year, the PEPP portfolio will be reduced by €7.5 billion per month on average. At the end of 2024, reinvestments under PEPP will be discontinued.
Refinancing operations will be adjusted depending on future needs. The Governing Council will regularly assess how targeted lending operations and their repayment contribute to the monetary policy stance. The Transmission Protection Instrument remains available to tackle any threats to the smooth functioning of monetary policy across the euro area.
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The above ECB Monetary Policy Statement was announced on a press confrence, followed by a Q&A session, whose topics we wold like to briefly present below:
Regarding Market Expectations and Rate Trajectory
The ECB emphasizes data dependence over time dependence in monetary policy decisions. The Governing Council uses three criteria: inflation outlook, underlying inflation, and monetary policy transmission strength. The ECB’s projections indicate a decline in inflation expectations and a flatter inflation trajectory, with a projection of 2.1% headline inflation in 2025. Underlying inflation is below expectations, and the monetary policy exhibits strong transmission, particularly concerning loans to corporates and households. Market expectations on future rates, influenced by the Fed’s explicit potential of three rate cuts for the upcoming year, are separate from the ECB’s approach, which remains focused on European data and conditions.
PEPP Reinvestments and the Interest Rate Path
PEPP reinvestments will stop by the end of 2024 following a majority agreement among governors, with a gradual reduction until then. The ECB acts independently of PEPP decisions in adjusting interest rates, which are the primary tool. There has been no discussion of rate cuts in the ECB meetings, indicating a steady approach towards interest rate decisions, shaped by a need for more data on wages and domestic inflation resistance.
Impact of Data on Monetary Policy and Fiscal Measures
The ECB will be particularly attentive to wage and profit data due in 2024, important for assessing inflation and economic conditions. The ECB encourages reduced sovereign debt and the withdrawal of fiscal measures compensating for high energy prices, alongside a call for structural reforms to boost euro area competitiveness. No specific countries have been targeted in this context.
Recession Risks and Balance Sheet Normalisation
The ECB’s current projections do not predict a recession in the euro area, with the central goal being the medium-term inflation target of 2%, not prompting a recession. Despite ending PEPP reinvestments, flexibility remains until the end of 2024, and other tools are available to address potential market fragmentation.
German Fiscal Measures and Inflation
It is too early to assess the impact of the newly announced German fiscal measures, including the higher carbon tax, on inflation in the eurozone, but their effects will be evaluated in future ECB projections. The ECB is also closely monitoring the contribution of wages and profits to inflation, noting a decline in unit profits‘ contribution and acknowledging potential risks of a wage-price spiral if these trends do not prove sustainable.