At its monetary policy meeting in Frankfurt on Thursday 14 December, the Governing Council of the European Central Bank (ECB) decided, as expected, not to change its three key interest rates. The interest rate on the deposit facility therefore remains at the historic level of 4.00%, the rate on the main refinancing operations at 4.5% and the rate on the marginal lending facility at 4.75%.
Furthermore, with regard to the ECB’s balance sheet, and in line with the possibility raised by ECB President Christine Lagarde at the most recent Monetary Dialogue in the European Parliament (see EUROPE 13301/20), the Governing Council has announced its intention to reduce the portfolio of the Pandemic Emergency Purchase Programme (PEPP) by an average of €7.5 billion per month in the second half of 2024 and to stop reinvesting in the PEPP by the end of 2024. This announcement comes a few months after the May announcement that reinvestments under the APP asset purchase programme would cease from July 2023 (see EUROPE 13175/9, 13202/6).
Christine Lagarde indicated that the measure had been taken by a very large majority of governors. There was consensus on the end of PEPP reinvestments at the end of 2024, and only differences of opinion on the timetable for its implementation.
Ms Lagarde stressed that this was a welcome normalisation of the balance sheet, adding that there was no longer the urgency of the Covid-19 pandemic and that the decision came at a time when the Eurosystem did not foresee any fragmentation in the euro area.
However, she added, if such a risk were to emerge, the ECB has tools at its disposal and would not hesitate to use them. On the other hand, the President emphasised that the ECB still had the flexibility to reinvest under the PEPP for as long as the reinvestments lasted.
The President pointed out that there was no direct link between the decisions concerning the PEPP and the ECB’s interest rate policy.
Furthermore, there was no mention of a rate cut at the meeting.
Finally, the President indicated that the ECB believed that the transmission of previous rate hikes to the economy remained strong.
Macroeconomic projections for the euro area
Although a small rise in inflation is possible this month, linked to energy costs, the Eurosystem believes that inflation should continue to fall gradually in the euro area in 2024.
Headline inflation projections
Eurosystem staff are forecasting headline inflation in the euro area to average 5.4% in 2023, 2.7% in 2024, 2.1% in 2025 and 1.9% in 2026. These projections have been revised downwards for 2023 and even further for 2024 compared with the September forecasts (see EUROPE 13280/8).
As far as underlying inflation is concerned, it is continuing to slow, but prices remain high, due in particular, according to the ECB President, to the dynamics of unit labour costs. Eurosystem staff estimate that inflation, excluding energy and food, will average 5.0% in 2023, 2.7% in 2024, 2.3% in 2025 and 2.1% in 2026.
However, the ECB President insisted that we should not let our guard down, given that the inflation outlook, which is one of the three criteria informing the Governing Council’s decisions, is linked to the interest rate path that was embedded in the market data at the time the Eurosystem’s deadline was set (23 November).
Underlying inflation projections
On the other hand, in examining measures of underlying inflation, the Eurosystem has noted a resilience in domestic inflation, which, Ms Lagarde points out, is largely dependent on wages. The President therefore indicated that the Eurosystem would need more data, particularly on wages.
In this respect, a large amount of macroeconomic data will be published in 2024.
The President emphasised that the Eurosystem was looking very carefully at what it believed to be a reduction in the contribution of profit units to inflation over the course of 2023. However, the President indicated that the Eurosystem would need more information and had to ensure that this indication was confirmed and that the phenomenon was sustainable. If this were confirmed, Christine Lagarde pointed out, it would mean that the hypotheses that margins would be reduced in order to absorb the increase in salaries by means of a catch-up or otherwise would be borne out. This would be very good news for the inflation targets, she stressed.
Growth projections
Finally, growth in the euro area is likely to remain moderate in the short term.
However, President Lagarde indicated that the ECB did not foresee a short-term recession in the euro area as a whole.
Real GDP should rebound, on average, from 0.6% in 2023 to 0.8% in 2024 and 1.5% in 2025 and 2026.
Future decisions by the Governing Council
In addition, the ECB still considers that its key interest rates are at levels which, if maintained for a sufficiently long period, will make a significant contribution to achieving its medium-term inflation target of 2%.
The Governing Council maintains its monetary policy decision-making method: decisions will be taken on a meeting by meeting basis, data-dependent and on the application of three criteria: the inflation outlook in the light of economic and financial data, the dynamics of underlying inflation and the transmission strength of its monetary policy. “We are dependent on data, not time”, said Christine Lagarde.
Link to the decisions: https://aeur.eu/f/a5k
Link to macroeconomic projections: https://aeur.eu/f/a5e (Original version in French by Émilie Vanderhulst)