The European Central Bank maintains current interest rates and reduces inflation projections
Thursday marked the second consecutive meeting of the European Central Bank, during which it kept interest rates unchanged, lowered its growth forecasts, and revealed plans to accelerate the reduction of its balance sheet.
Given the precipitous decline in inflation inside the Eurozone, market participants were anticipating an unaltered policy unaltered announcement. Instead, they were keeping an eye out for clues about the timing of the first rate drop and evaluating the ECB’s intentions to reduce its balance sheet.
The statement from the Governing Council stated that “its policy rates will be set at sufficiently restrictive levels for as long as necessary.” This guarantee will be in place through future decisions. But the ECB changed its tone on inflation from “expected to remain too high for too long” to “decline gradually over the course of next year.”
Up from a previous prediction of 0.7%, the most recent staff macroeconomic estimates indicate an average real GDP expansion of 0.6% in 2023. From 1% in 2023, they project a 0.8% increase in GDP in 2024. The prediction for 2025 remained at 1.5%.
Meanwhile, general predictions for headline inflation in 2023, 2024, and 2025 are 5.4%, 2.7%, and 2.1%, respectively. Predictions for this year, 2024, and 2025 were 5.6%, 3.2%, and 2.1%, respectively. The ECB has also provided a revised projection for 2026, indicating a rate of 1.9%.
Domestic pricing pressures are still high, the ECB said, mostly due to rising labor costs. Inflation members expect to see this year average 5%, 2.7% in 2024, 2.3% in 2025, and 2.1% in 2026, excluding food and energy.
It predicted that growth would be modest in the near run but would pick up speed as a result of rising real earnings and better foreign demand, and that tighter financing conditions were reducing demand and helping to manage inflation.
The central bank’s benchmark rate will remain at its record high of 4% as a result of the decision.
The European Central Bank also said that by the end of 2024, all reinvestments made under its temporary asset purchase plan, the Pandemic Emergency Purchase Program (PEPP), will have concluded.
According to the statement, the PEPP portfolio would be reduced by an average of 7.5 billion euros ($8.19 billion) each month during the second half of 2024 as a result of the Governing Council’s decision to “advance the normalization of the Eurosystem’s balance sheet.” After ending reinvestments this summer under its Asset Purchase Program, a stimulus plan that began buying bonds in mid-2014 to combat low inflation, the central bank has effectively tightened all of its policymaking instruments.
According to James Smith, a developed market economist at ING, “I think most people thought [the announcement on PEPP] would come a little bit later, might come in the rate cut debate, and was the sort of price that the doves would have to pay” (CNBC’s Joumanna Bercetche, 2013).
Fall in inflation
The most current annual rate of inflation in the Eurozone was 2.4% in November, down from 10.6% in October 2022. As a result, the ECB’s 2% objective is now within reach, but authorities are nonetheless warning of a possible rebound due to wage pressures and energy market uncertainty.
It has also increased the likelihood that cutbacks will occur next year; market prices and some analysts have speculated that this may happen before summer.
Christine Lagarde, president of the European Central Bank, told CNBC’s Annette Weisbach that the bank was “data dependent, not time dependent” when asked about the timing of cutbacks during a press conference that followed the decision.
“Inflation is projected to be 2.1% in 2025, according to our projections, and the road to that goal is flatter than it was before, so there’s less of a chance that inflation expectations will deanchor,” Lagarde stated.
“Underlying inflation falls short of expectations, with a decrease across all components,” according to many measures.
Her question was this: “Should we let our guard down?” That is the inquiry we pose to ourselves. No way; we must never, ever let our guard down.
Lagarde attributed this to the persistence of the danger of domestic inflation and mentioned that new pay data would be available in the spring as additional factors to consider.
On Thursday, European bond prices rose and the regional Stoxx 600 index hit its highest level since January 2022, leading to gains for European exchanges generally.
The euro maintained its gains following the ECB statement and is now trading at $1.095, up 0.8% vs. the dollar. Furthermore, it reversed a little loss to trade at parity with the British pound.
After deciding on Wednesday to keep interest rates constant and reveal the most recent “dot plot” rate trajectory from its members, the U.S. Federal Reserve’s actions were expected to lead to a dovish shift from major central banks. These changes partially reflected the decision.
Following the announcement of a rate hold by the Bank of England committee at noon U.K. time, the market maintained its gains. This was accompanied by the statement that monetary policy was “likely to need to be restrictive for an extended period of time.”