14 December 2023
Monetary policy decisions
The Governing Council today decided to keep the three key ECB interest rates unchanged. While inflation has dropped in recent months, it is likely to pick up again temporarily in the near term. According to the latest Eurosystem staff projections for the euro area, inflation is expected to decline gradually over the course of next year, before approaching the Governing Council’s 2% target in 2025. Overall, staff expect headline inflation to average 5.4% in 2023, 2.7% in 2024, 2.1% in 2025 and 1.9% in 2026. Compared with the September staff projections, this amounts to a downward revision for 2023 and especially for 2024.
Underlying inflation has eased further. But domestic price pressures remain elevated, primarily owing to strong growth in unit labour costs. Eurosystem staff expect inflation excluding energy and food to average 5.0% in 2023, 2.7% in 2024, 2.3% in 2025 and 2.1% in 2026.
The past interest rate increases continue to be transmitted forcefully to the economy. Tighter financing conditions are dampening demand, and this is helping to push down inflation. Eurosystem staff expect economic growth to remain subdued in the near term. Beyond that, the economy is expected to recover because of rising real incomes – as people benefit from falling inflation and growing wages – and improving foreign demand. Eurosystem staff therefore see growth picking up from an average of 0.6% for 2023 to 0.8% for 2024, and to 1.5% for both 2025 and 2026.
The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. The Governing Council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary.
The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, its interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission.
The key ECB interest rates are the primary tool for setting the monetary policy stance. The Governing Council also decided today to advance the normalisation of the Eurosystem’s balance sheet. It intends to continue to reinvest, in full, the principal payments from maturing securities purchased under the pandemic emergency purchase programme (PEPP) during the first half of 2024. Over the second half of the year, it intends to reduce the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.
Key ECB interest rates
The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 4.50%, 4.75% and 4.00% respectively.
Asset purchase programme (APP) and pandemic emergency purchase programme (PEPP)
The APP portfolio is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.
The Governing Council intends to continue to reinvest, in full, the principal payments from maturing securities purchased under the PEPP during the first half of 2024. Over the second half of the year, it intends to reduce the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.
The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.
Refinancing operations
As banks are repaying the amounts borrowed under the targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted lending operations and their ongoing repayment are contributing to its monetary policy stance.
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The Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its 2% target over the medium term and to preserve the smooth functioning of monetary policy transmission. Moreover, the Transmission Protection Instrument is available to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across all euro area countries, thus allowing the Governing Council to more effectively deliver on its price stability mandate.
Source – ECB
Christine Lagarde, President of the ECB, Luis de Guindos, Vice-President of the ECB
Frankfurt am Main, 14 December 2023
Jump to the transcript of the questions and answersGood afternoon, the Vice-President and I welcome you to our press conference.
The Governing Council today decided to keep the three key ECB interest rates unchanged. While inflation has dropped in recent months, it is likely to pick up again temporarily in the near term. According to the latest Eurosystem staff projections for the euro area, inflation is expected to decline gradually over the course of next year, before approaching our two per cent target in 2025. Overall, staff expect headline inflation to average 5.4 per cent in 2023, 2.7 per cent in 2024, 2.1 per cent in 2025 and 1.9 per cent in 2026. Compared with the September staff projections, this amounts to a downward revision for 2023 and especially for 2024.
Underlying inflation has eased further. But domestic price pressures remain elevated, primarily owing to strong growth in unit labour costs. Eurosystem staff expect inflation excluding energy and food to average 5.0 per cent in 2023, 2.7 per cent in 2024, 2.3 per cent in 2025 and 2.1 per cent in 2026.
Our past interest rate increases continue to be transmitted forcefully to the economy. Tighter financing conditions are dampening demand, and this is helping to push down inflation. Eurosystem staff expect economic growth to remain subdued in the near term. Beyond that, the economy is expected to recover because of rising real incomes – as people benefit from falling inflation and growing wages – and improving foreign demand. Eurosystem staff therefore see growth picking up from an average of 0.6 per cent for 2023 to 0.8 per cent for 2024, and to 1.5 per cent for both 2025 and 2026.
We are determined to ensure that inflation returns to our two per cent medium-term target in a timely manner. Based on our current assessment, we consider that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. Our future decisions will ensure that our policy rates will be set at sufficiently restrictive levels for as long as necessary.
We will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, our interest rate decisions will be based on our assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission.
The key ECB interest rates are our primary tool for setting the monetary policy stance. We also decided today to advance the normalisation of the Eurosystem’s balance sheet. The Governing Council intends to continue to reinvest, in full, the principal payments from maturing securities purchased under the pandemic emergency purchase programme (PEPP) during the first half of 2024. Over the second half of the year, it intends to reduce the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.
The decisions taken today are set out in a press release available on our website.
I will now outline in more detail how we see the economy and inflation developing and will then explain our assessment of financial and monetary conditions.
Economic activity
The euro area economy contracted slightly in the third quarter, mostly owing to a decline in inventories. Tighter financing conditions and subdued foreign demand are likely to continue weighing on economic activity in the near term. Prospects are especially weak for construction and manufacturing, the two sectors most affected by higher interest rates. Services activity is also set to soften in the coming months. This is due to spillovers from weaker industrial activity, fading effects from the reopening of the economy and the broadening impact of tighter financing conditions.
The labour market continues to support the economy. The unemployment rate stood at 6.5 per cent in October and employment grew by 0.2 per cent over the third quarter. At the same time, the weaker economy is dampening the demand for workers, with firms advertising fewer vacancies in recent months. Moreover, even though more people are in work, the total number of hours worked edged down by 0.1 per cent in the third quarter.
As the energy crisis fades, governments should continue to roll back the related support measures. This is essential to avoid driving up medium-term inflationary pressures, which would otherwise call for even tighter monetary policy. Fiscal policies should be designed to make our economy more productive and to gradually bring down high public debt. Structural reforms and investments to enhance the euro area’s supply capacity – which would be supported by the full implementation of the Next Generation EU programme – can help reduce price pressures in the medium term, while supporting the green and digital transitions. To that end, it is important to swiftly agree on the reform of the EU’s economic governance framework. Moreover, it is imperative that progress towards Capital Markets Union and the completion of Banking Union be accelerated.
Inflation
Inflation dropped over the past two months, falling to an annual rate of 2.4 per cent in November according to Eurostat’s flash release. This decline was broad-based. Energy price inflation fell further and food price inflation also came down, despite remaining relatively high overall. This month, inflation is likely to pick up on account of an upward base effect for the cost of energy. In 2024, we expect inflation to decline more slowly because of further upward base effects and the phasing-out of past fiscal measures aimed at limiting the repercussions of the energy price shock.
Inflation excluding energy and food dropped by almost a full percentage point over the past two months, falling to 3.6 per cent in November. This reflects improving supply conditions, the fading effects of the past energy shock and the impact of tighter monetary policy on demand and on the pricing power of firms. The inflation rates for goods and services fell to 2.9 per cent and 4.0 per cent respectively.
All measures of underlying inflation declined in October, but domestic price pressures remained elevated, chiefly because of strong wage growth together with falling productivity. Measures of longer-term inflation expectations mostly stand around 2 per cent, with some market-based indicators of inflation compensation declining from elevated levels.
Risk assessment
The risks to economic growth remain tilted to the downside. Growth could be lower if the effects of monetary policy turn out stronger than expected. A weaker world economy or a further slowdown in global trade would also weigh on euro area growth. Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East are key sources of geopolitical risk. This may result in firms and households becoming less confident about the future. Growth could be higher if rising real incomes raise spending by more than anticipated, or the world economy grows more strongly than expected.
Upside risks to inflation include the heightened geopolitical tensions, which could raise energy prices in the near term, and extreme weather events, which could drive up food prices. Inflation could also turn out higher than anticipated if inflation expectations were to move above our target, or if wages or profit margins increased by more than expected. By contrast, inflation may surprise on the downside if monetary policy dampens demand by more than expected or the economic environment in the rest of the world worsens unexpectedly, potentially owing in part to the recent rise in geopolitical risks.
Financial and monetary conditions
Market interest rates have fallen markedly since our last meeting and lie below the rates embedded in the staff projections. Our restrictive monetary policy continues to transmit strongly into broader financing conditions. Lending rates rose again in October, to 5.3 per cent for business loans and 3.9 per cent for mortgages.
Higher borrowing rates, subdued loan demand and tighter loan supply have further weakened credit dynamics. Loans to firms declined at an annual rate of 0.3 per cent in October and loans to households also remained subdued, growing at an annual rate of 0.6 per cent. With weaker lending and the reduction in the Eurosystem balance sheet, broad money – as measured by M3 – has continued to contract. In October it fell at an annual rate of 1.0 per cent.
In line with our monetary policy strategy, the Governing Council thoroughly assessed the links between monetary policy and financial stability. Euro area banks have demonstrated their resilience. They have high capital ratios and have become significantly more profitable over the past year. But the financial stability outlook remains fragile in the current environment of tightening financing conditions, weak growth and geopolitical tensions. In particular, the situation could worsen if banks’ funding costs were to increase by more than expected and if more borrowers were to struggle to repay their loans. At the same time, the overall impact of such a scenario on the economy should be contained if financial markets react in an orderly fashion. Macroprudential policy remains the first line of defence against the build-up of financial vulnerabilities, and the measures in place contribute to preserving the financial system’s resilience.
Conclusion
The Governing Council today decided to keep the three key ECB interest rates unchanged. We are determined to ensure that inflation returns to our two per cent medium-term target in a timely manner. Based on our current assessment, we consider that rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to our target. Our future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary to ensure such a timely return. We will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction.
The Governing Council intends to reduce the PEPP portfolio over the second half of 2024 and to discontinue its reinvestments under the PEPP at the end of 2024.
In any case, we stand ready to adjust all of our instruments within our mandate to ensure that inflation returns to our medium-term target and to preserve the smooth functioning of monetary policy transmission.
We are now ready to take your questions.
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I have two questions. The first one is on the market expectations about the future rate trajectory, especially after the Fed yesterday was quite explicit about the potential of three rate cuts during the course of next year. So what is the ECB’s thinking? The second is on the pandemic emergency purchase programme (PEPP): Is the PEPP a prerequisite – or the earlier stop of reinvestments or fading out of reinvestments – is that a prerequisite for having rate cuts and does that make them also likely to start in March?
Thank you very much for your two questions. But let me remind you of one thing. We are data dependent. We are not time dependent. We are data dependent. And let me take you into the Governing Council room. As you remember, we have defined the three key criteria of our monetary policy stance, namely inflation outlook, underlying inflation, transmission – strength of the transmission of our monetary policy. And it is against those three criteria that we determine whether enough progress has been made and whether our monetary policy is working. And clearly, when we look at our inflation outlook, at the projections produced by staff and the entire Eurosystem on the occasion of the December meeting, our new projections see inflation at 2.1% in 2025, not 2026, which is included, but in 2025 we see headline at 2.1%. And the path to get there is flatter than it was before, which lowers the risks of inflation expectations risking de-anchoring. That’s on the inflation outlook. On underlying inflation, the monetary policy statement says quite specifically that a lot of indicators are showing that underlying inflation comes in below expectations, with a decline across all components. When we look at transmission, we are clearly seeing a strong transmission to the financing of the economy and strong transmission at large, particularly if we look at the volume of loans to both corporates and the households.
Should we lower our guard? We asked ourselves that question. No, we should absolutely not lower our guard. I’ll give you two good reasons for that. The first one is that our inflation outlook, which is one of the three criteria, is conditioned on the interest rate path that was embedded in market data at the time when our cut-off date was determined. The cut-off date, as you will see in the publication, was November 23rd. So that’s point number one. Point number two: when we look at all the measurements of underlying inflation, there is one particular measurement which is hardly budging. It’s declining a little bit, but not much, and that is domestic inflation. And domestic inflation is largely predicated by wages. We need more data, we need to understand better what happens there and why is domestic inflation resisting. To understand that, we need a category of things. Number one, we need wage data. And that is going to be measured in multiple ways. We have really as wide an area of indicators for that; the wage tracker, the number of job offers, the vacancies that turn around, plenty of them. That of course determines how tight the market is and therefore how wages will behave in the next few months.
When we look at the data that we have now, it is not declining. Compensation per employee has declined from Q2 to Q3, that’s true. But the other indicators no. So we need to have a lot more data in that regard. And the second element, which is critical given the way we have constructed our projections, the way staff has constructed projections, we need more information about unit profits as well. Because our projection is predicated on the assumption that a lot of the catch-up wage growth will actually be absorbed in the markup of enterprises and corporates. So we need to have these two on a more sustainable basis, demonstrating that domestic inflation too is going to head down towards our target. We don’t have that yet. We will have a lot more data in the course of 2024. It will be particularly rich in the first half, but we will need that in order to determine whether it is actually sustainable or not.
Now you had a second question, which had to do with PEPP. Let me just tell you how I regard the decision that we made on PEPP and that was shared by a very, very large majority of the governors. Everybody was fine with stopping the reinvestments at the end of 2024. Some would have liked a slightly different tapering, starting a little earlier, starting later. So we ended up with that 100% reinvestment until the end of June, 50% reinvestment from July until the end of December, no reinvestment from January 2025 onwards. This is really balance sheet normalisation. It’s a good moment to do that. We have little by way of fragmentation. Markets have absorbed a decline in asset purchase programme (APP) reinvestment as we had done it in a very similar fashion. So we think that it is really on a standalone basis and it will continue to operate on the back burner if you will, without, we hope, being significant. And that’s how we came to that decision. But it’s totally unrelated to “If they do that with PEPP, then maybe they’re planning this on rates”. No, rates are the primary tool and we’re going to use that independently of what happens on the PEPP side, which as I said is on the back burner.
Last night, J. Powell said that rate cuts have started to come into view and and were definitely a part of the discussion. The question I have is, is the same true for the ECB? Was there any discussion from anybody about rate cuts at some point and how it could be done? The second question is related to what you said a few weeks ago. You said you don’t expect rate changes for a couple of quarters ahead. Today, do you maintain that view or do you think data since then has evolved to a point where you would no longer keep that view?
Thank you very much for your two questions. On the first one, it is very easy. We did not discuss rate cuts at all. No discussion, no debate on this issue. And I think everybody in the room takes the view that between hike and cut, there’s a whole plateau, a whole beach of hold. It’s like solid, liquid and gas: you don’t go from solid to gas without going through the liquid phase. This was just not discussed. I think going forward, we are going to continue to be data dependent. We are going to continue to determine meeting by meeting what we see on the totality of data. But obviously, given a certain resistance of domestic inflation and the risk of second-round effects that we absolutely want to avoid, we’re going to be very attentive to that category of data that I have just described.
I have to come back to the rate outlook. You mentioned that a lot of data will arrive in the course of the first half on how wages and inflation will develop. By coincidence, PEPP reinvestments will also slow right around that time. So I would be interested in your view on whether that seems like a reasonable point in time to change your view on what kind of policy path for interest rates is needed and whether that would be a good moment to consider rate cuts. And the second question I have is on something you mentioned in your introductory statement. You said governments should rein in fiscal support or otherwise monetary policy might need to be tighter. Do you have any particular country in mind with that?
On your latter question, we don’t have any particular country in mind. I think we have the principle in mind that the fiscal support, particularly the discretionary support that was granted to compensate for the high prices of energy, that should absolutely be withdrawn. When you look at how fast the price of energy has gone down, both on the oil and gas front, it’s just totally unjustified and probably unjustifiable to continue to have those fiscal measures in place. But no particular identification of any particular country. I think we make the point in that same paragraph that we strongly encourage the reduction of the sovereign debt. We make the point that fiscal measures must be rolled back and that sovereign debt must be reduced. And we make another point, which as you will have noted because you’re a regular of these monetary policy statements: we have changed the language on structural reforms. And we have done that because we perceive and we fear a level of procrastination in reaching agreement in closing on some of the technical files, which have been pending for way too long and which would be critical in order to support the competitiveness of the euro area. You will see when we publish the data that competitiveness is really weakening. And whether it’s capital markets union, whether it’s banking union or the whole market union and free movement of goods and services, a lot of progress needs to be made. And that point was made very clearly. The Vice President is a very strong supporter of that. And there were many voices on the Governing Council to say in the presence of Valdis Dombrovsky, who is working on those issues, that it has to happen.
On your first question: it is true that we will receive a lot of data in the first half of 2024. So it will be data rich, particularly on the employment front. Just consider that about 50% of the employees that we cover under our wage tracker will see their collective bargaining agreement renegotiated and new terms of employment and possibly new wages agreed upon. And in the same vein in the corporate world whether it’s for goods or services, terms and conditions and price lists are also often revised in the first few months of any calendar year. But that’s not to say that this will be it. We will remain attentive to a whole host of data that will come in in the course of 2024.
Firstly, if I could just ask you about comments that the Federal Reserve Chair Jay Powell made yesterday evening. He said that there was the risk that they would hang on too long with rates at the current level, and he said that they were very focused on not making the mistake of holding on too long at a high level. Do you share that concern? And secondly, if I could ask about market expectations and market pricing in a slightly different way: Do you think that the current market pricing, which is for the ECB to cut rates six times next year starting from March, is reasonable? Does that seem fair to you?
On your first question: Who wants to hang on for too long? But equally what we are saying today, on the basis of the forecast that we have, which has been produced by the Eurosystem staff, is that we don’t think that it’s time to lower our guard, and we believe that there is still work to be done and that can very much take the form of holding. I think in our monetary policy statement, what we essentially say and have said before is: based on our current assessment, we consider that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to our goal. And we continue with: our future decisions will ensure that our policy rates will be set at sufficiently restrictive levels for as long as necessary. If you combine that with our data dependency, and the fact that we are not narrowing the focus of what we look at, but we know that some data, and a combination of data and the mechanics between these two, wages and profit in particular, are going to play a significant role, and we will be particularly attentive to those. There will be more data coming in. We will have another bank lending survey, we will have a corporate telephone survey coming in, and we will take that into account to determine when we can lower the guard. That’s where we are at the moment.
I am of course not going to address your second question directly. I will simply say that we will be looking at our three criteria. We will be identifying, on the basis of staff forecasts, on the basis of our measurements and of underlying inflation, and on the basis of the strong transmission of our monetary policy, where we are regarding this medium term target that we have set ourselves, of reaching the 2% target at the end of our projection. We are probably a little bit more severe with ourselves because the end of our projection or the end of the projection horizon would take us to 2026, where we have 1.9%. We are probably going to look very carefully at the end of 2025, where I think we are at 2.1%, and we will arrive on a more sliding basis to that 2.1%. That’s what we are going to be doing. The projections that we have now are conditioned on the interest rate path that was embedded in market data before the cut-off date of 23rd November.
My first question regards some countries that are entering a recession and seeing the projections with growth picking up: how much is the risk of recession and things getting worse taken into account in decisions today and when it comes to interest rates? And then I have a question about PEPP: you said in the past that flexibility in PEPP reinvestments is the first line of defence against the risk of fragmentation. And you just said it is currently a good moment. This sounds like big news – that the risk of fragmentation is not a worry – but can you say a bit more about this?
First of all, let me say that we do not have a recession in our baseline. Of course I’m not looking at specific countries, we are looking collectively at the euro area at large. Our mandate is not to cause a recession. Our mandate is to reach the medium-term target of 2%, which we have defined as price stability. To do that, we know that we’re going to have to continue with financing, which will be triggered by the interest rates that we set. That financing will necessarily dampen demand. We are seeing it. We take all the macroeconomic data and the whole situation into account, but we are driven by delivering on our mandate.
On PEPP: first of all, don’t forget that as long as we reinvest – by which I mean 100% of redemption coming to maturity – we still have that flexibility. It was one of the attributes of PEPP. And that flexibility applies to the 100% reinvestment until the end of June, and then to 50% of the reinvestment until the end of the 2024 calendar year. We believe that PEPP has served its purpose. It was intended for the pandemic, it was an emergency programme. Despite stupid Covid-19 coming to hit you now and again – as it hit me – the pandemic is over. The WHO has declared so. The emergency is no longer around. Obviously it’s a normalisation of the balance sheet that is welcome at a time when we don’t actually currently see a risk of fragmentation. If there were such risks, we also have tools that are available, that we would not hesitate to use for a second, because proper transmission is actually part of the mission.
Firstly, the German government has just passed some kind of savings package that includes, for example, a higher carbon tax. To what extent will this affect inflation in the eurozone? Secondly, if I understood you correctly, the main driver for the relatively stubborn inflation in the coming month will be wages and profits. Does this mean that there’s still some kind of risk for some kind of wage price spiral or is it something else?
On your first question: it’s obviously premature. The announcement from the German coalition about the decision came yesterday. We have not included those numbers and their forecast into our current projections, and obviously we will do so and we will try to understand exactly what impact it would have. Germany is a big country, it represents roughly 25% of the euro area and fiscal measures that would be taken need to be accounted for and the impact on inflation determined. So we will do that.
Thank you for finishing with the wage and profit question, because it’s something that staff – both here at the ECB but also in the national central banks – looks at very, very carefully. And what we have seen is a contribution from unit profits to inflation declining over the course of 2023. From memory, the contribution was at about 2.4% and it’s now down to 1.4%. Now, it’s a big “if” and we need to really understand and make sure that this is sustainable, but if that is confirmed, it would mean that the hypotheticals that we had in our previous forecast and that we have for this forecast in December – which was that markups would be reduced in order to absorb increased wages by way of catch-up or otherwise – that that is actually taking place, which would be really good news for inflation purposes. But we don’t have enough on the table to really determine that this is what is going to happen. We will.
Source – ECB