BRUSSELS, BELGIUM – NOVEMBER 27: Christine Lagarde, President of the European Central Bank speaks during the meeting of the Committee on Economic and Monetary Affairs (ECON) of the European Parliament in Brussels, Belgium on November 27, 2023. (Photo by Dursun Aydemir/Anadolu via Getty Images)
Anadolu | Anadolu | Getty Images
The European Central Bank kept interest rates stable for the second time in a row on Thursday, after downgrading its growth outlook and announcing plans to accelerate its balance sheet reduction.
The bank was widely expected to keep policy unchanged in light of the sharp fall in eurozone inflation, as investors instead chase signals when the first rate cut could come and the ECB’s plans to overhaul its balance sheet reduce, would assess.
“The Governing Council’s future decisions will ensure that the policy rate is set at sufficiently restrictive levels for as long as necessary,” the Council said in a statement. However, the ECB changed language around inflation, describing it not as “expected to remain too high for too long” but instead as “gradually declining over the course of next year.”
According to the latest staff macroeconomic projections, average real GDP will grow by 0.6% in 2023, up from a previous forecast of 0.7%. They estimate that GDP will grow 0.8% in 2024, up from 1% previously. The forecast for 2025 remained unchanged at 1.5%.
Overall inflation, meanwhile, will average 5.4% in 2023, 2.7% in 2024 and 2.1% in 2025. She previously forecast figures of 5.6% this year, 3.2% in 2024 and 2, 1% in 2025. The ECB has now also published a new estimate. for 2026 at 1.9%.
The ECB warned that domestic price pressures remain high, mainly due to labor cost growth. Members see core inflation, excluding energy and food, averaging 5% this year and 2.7% in 2024, 2.3% in 2025 and 2.1% in 2026.
The report said tighter financing conditions dampened demand and helped contain inflation, adding that growth would be subdued in the near term before recovering due to rising real incomes and improved foreign demand.
The decision keeps the central bank’s policy rate at a record high of 4%.
The ECB also announced that reinvestments under its Pandemic Emergency Purchase Program (PEPP), a temporary asset purchase scheme, would be completed by the end of 2024.
The transition will be gradual, with a reduction of the PEPP portfolio by an average of 7.5 billion euros ($8.19 billion) per month over the second half of 2024, the report said, after the Governing Council agreed to “the to promote normalization of the Eurosystem’s balance sheet’. .” It means that all the instruments the central bank uses to determine monetary policy are now in a tightening mode, after this summer it halted reinvestments under its Asset Purchase Program. In mid-2014 launched a bond-buying stimulus package to address low inflation.
“I think that’s what most people thought [the announcement on PEPP] would come a little later, could come into the interest rate cut debate and was the kind of price the pigeons would have to pay,” James Smith, developed market economist at ING, told CNBC’s Joumanna Bercetche after the announcement.
Decrease in inflation
Eurozone annual inflation fell from 10.6% in October 2022 to 2.4% in the most recent reading in November. That has put the ECB’s 2% target within reach, even as officials point to the threat that wage pressures and energy market volatility will trigger a potential rebound.
It has also fueled bets on cuts next year, with some analysts and market prices suggesting the cuts could happen before the summer.
Asked about the timing of the cuts at a press conference after the announcement, ECB President Christine Lagarde told CNBC’s Annette Weisbach that the central bank was “data-dependent, not time-dependent.”
“When we look at our inflation outlook, at the projections, we clearly see 2.1% inflation in 2025… said.
“Many indicators show that underlying inflation remains below expectations, with a decline in all components.”
She continued, “So should we let our guard down? We ask ourselves that question. No, we absolutely should not let down our guard.’
A key reason for that is the persistent risk of domestic inflation, Lagarde said, adding that new payroll data will need to be assessed in the spring.
Market response
The European stock exchanges gained ground with the regional ones until Thursday Stoxx 600 The index reached its highest level since January 2022, while European bonds recovered.
Following the ECB news, the euro extended its gains and traded 0.8% higher against the dollar at $1.095. It also went from a slight loss to flat trading against the British pound.
The moves partly reflected the U.S. Federal Reserve’s decision on Wednesday to hold rates steady and release its members’ latest interest rate trajectory, raising expectations of an easing of interest rates at major central banks.
The gains were sustained after the Bank of England also announced a rate cut at noon UK time, even as the committee said monetary policy was “likely to be restrictive for an extended period”.