Against a background of inflation and inflation projections deemed too high in relation to the symmetrical objective of 2% headline inflation in the medium term, the Governing Council of the European Central Bank (ECB), meeting in Frankfurt on Thursday 4 May, decided to continue tightening the ECB’s monetary policy.
The Governing Council announced a small increase of 25 basis points in the three key ECB interest rates. Thus, the interest rates on the main refinancing operations, the marginal lending facility and the deposit facility will be raised to 3.75, 4.00 and 3.25% respectively from 10 May.
But above all, the Governing Council announced its intention to accelerate the reduction of the ECB’s balance sheet by planning to stop reinvesting the amounts arising from the maturities of securities acquired under the asset purchase programme (APP) from July 2023.
This decision only concerns reinvestments under the APP, not reinvestments under the Pandemic Emergency Purchase Programme (PEPP), which remains a flexible ECB policy tool.
Decision-making in the Governing Council
ECB President Christine Lagarde pointed out that different views on the rate hike were expressed at the meeting. According to her, some members of the Council spoke in favour of a 25 basis point increase, others for a 50 basis point increase, but none had spoken in favour of no increase.
Ms Lagarde ruled out the possibility of a deal that would make the moderate rate hike conditional on an accelerated tightening of the ECB’s balance sheet.
She added that some Council members would have liked to have waited until the June meeting to make the announcement, but that due to the principle of predictability, the Governing Council had considered it best to make the announcement at this May meeting, while leaving an optionality “just in case”.
The ECB President reiterated the Governing Council’s new decision-making method: a method that is no longer linked to forward guidance, but to a data-dependent approach and based on three criteria, applied on a meeting-by-meeting basis. “We have articulated the reaction function of our monetary policy decisions with the three key elements of the inflation outlooks, informed by the financial and economic data, the underlying inflation [using several measures to try to understand the inflation developments, editor’s note], and the strength of the monetary policy transmission”.
Transmission of monetary policy
On the transmission of monetary policy, Christine Lagarde highlighted the Bank Lending Survey (BLS) published on 4 April. The President said that the ECB’s rate hike had started to have an impact, especially on loan applications by businesses.
She said that the information contained in the BLS as well as the earlier interest rate data from February indicated an effective transmission of the ECB’s monetary policy.
The data indicate a weakening of credit, in particular a weakening of demand for corporate loans.
Ms Lagarde added that there was uncertainty about the transmission of monetary policy from banks to the real economy.
TLTRO lll
Ms Lagarde considered that, thanks to the opportunities for voluntary early repayment of funds obtained under the third round of targeted longer-term refinancing operations (TLTRO III), the cliff effect should be avoided.
The President indicated that banks would no longer have to pay back around 1,000 billion in June, but around 477. She said that the banks are prepared and that there would be no surprises.
She added that, if anything, the ECB had demonstrated that it could be inventive on the liquidity front.
The future
Christine Lagarde said that the ECB still had more ground to cover and that it was not taking a break from tightening monetary policy.
Describing this policy, Ms Lagarde said, “Is it restrictive? Yes. Sufficiently? Not yet”.
Finally, referring to the end of APP reinvestments and the ‘tilting mechanism’, the President drew the journalists’ attention to the reflections on “how we can continue to deliver on our Paris Agreement compliant investment and reinvestment programme without the reinvestment phase".
Link to Christine Lagarde’s decisions and statement: https://aeur.eu/f/6pm (Original version in French by Émilie Vanderhulst)