Monetary policy statement (with Q&A)
Central bank: ecb | Type: press_conference | Date: 2023-10-26

INTRODUCTORY STATEMENT

Good afternoon, the Vice-President and I welcome you to our press conference. I would like to thank Governor Stournaras for his kind hospitality and express our special gratitude to his staff for the excellent organisation of today’s meeting of the Governing Council.
The Governing Council today decided to keep the three key ECB interest rates unchanged. The incoming information has broadly confirmed our previous assessment of the medium-term inflation outlook. Inflation is still expected to stay too high for too long, and domestic price pressures remain strong. At the same time, inflation dropped markedly in September, including due to strong base effects, and most measures of underlying inflation have continued to ease. Our past interest rate increases continue to be transmitted forcefully into financing conditions. This isincreasingly dampening demand and thereby helps push down inflation.
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 thatthe 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 decisions taken today are set out in apress releaseavailable 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.
The euro area economy remains weak. Recent information suggests that manufacturing output has continued to fall. Subdued foreign demand and tighter financing conditions are increasingly weighing on investment and consumer spending. The services sector is also weakening further. This is mainly because weaker industrial activity is spilling over to other sectors, the impetus from reopening effects is fading and the impact of higher interest rates is broadening. The economy is likely to remain weak for the remainder of this year. But as inflation falls further, household real incomes recover and the demand for euro area exports picks up, the economy should strengthen over the coming years.
Economic activity has so far been supported by the strength of the labour market. The unemployment rate stood at a historical low of 6.4 per cent in August. At the same time, there are signs that the labour market is weakening. Fewer new jobs are being created, including in services, consistent with the cooling economy gradually feeding through to employment.
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, the reform of the EU’s economic governance framework should be concluded before the end of this year and progress towards Capital Markets Union and the completion of Banking Union should be accelerated.
Inflation dropped to 4.3 per cent in September, almost a full percentage point lower than its August level. In the near term, it is likely to come down further, as the sharp price increases in energy and food recorded in autumn 2022 will drop out of the yearly rates. September’s decline was broad-based. Food price inflation slowed again, although it remains high by historical standards. In annual terms, energy prices fell by 4.6 per cent but, most recently, have risen again and become less predictable in view of the new geopolitical tensions.
Inflation excluding energy and food dropped to 4.5 per cent in September, from 5.3 per cent in August. This fall was supported by improving supply conditions, the pass-through of previous declines in energy prices, and the impact of tighter monetary policy on demand and corporate pricing power. Goods and services inflation rates fell substantially, to 4.1 per cent and 4.7 per cent respectively, with services inflation also being pulled down by pronounced base effects. Price pressures in tourism and travel appear to be moderating.
Most measures of underlying inflation continue to decline. At the same time, domestic price pressures are still strong, reflecting also the growing importance of rising wages. Measures of longer-term inflation expectations mostly stand around 2 per cent. Nonetheless, some indicators remain elevated and need to be monitored closely.
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 would also weigh on growth.Russia’s unjustified war against Ukraine and the tragic conflict triggered by the terrorist attacks in Israel are key sources of geopolitical risk. This may result in firms and households becoming less confident and more uncertain about the future, and dampen growth further. Conversely, growth could be higher than expected if the still resilient labour market and rising real incomes mean that people and businesses become more confident and spend more, or the world economy grows more strongly than expected.
Upside risks to inflation could come from higher energy and food costs. The heightened geopolitical tensions could drive up energy prices in the near term, while making the medium-term outlook more uncertain. Extreme weather, and the unfolding climate crisis more broadly, could push food prices up by more than expected. A lasting rise in inflation expectations above our target, or higher than anticipated increases in wages or profit margins, could also drive inflation higher, including over the medium term. By contrast, weaker demand – for example owing to a stronger transmission of monetary policy or a worsening of the economic environment in the rest of the world amid greater geopolitical risks – would ease price pressures, especially over the medium term.
Longer-term interest rates have risen markedly since our last meeting, reflecting strong increases in other major economies. Our monetary policy continues to transmit strongly into broader financing conditions. Funding has become more expensive for banks, and interest rates for business loans and mortgages rose again in August, to 5.0 per cent and 3.9 per cent respectively.
Higher borrowing rates, with the associated cuts in investment plans and house purchases, led to a further sharp drop in credit demand in the third quarter, as reported in our latest bank lending survey. Moreover, credit standards for loans to firms and households tightened further. Banks are becoming more concerned about the risks faced by their customers and are less willing to take on risks themselves.
Against this background, credit dynamics have weakened further. The annual growth rate of loans to firms has dropped sharply, from 2.2 per cent in July to 0.7 per cent in August and 0.2 per cent in September. Loans to households remained subdued, with the growth rate slowing to 1.0 per cent in August and 0.8 per cent in September. Amid weak lending and the reduction in the Eurosystem balance sheet, the annual growth rate of M3 fell to -1.3 per cent in August – the lowest level recorded since the start of the euro – and still stood at -1.2 per cent in September.
The Governing Council today decided to keep the three key ECB interest rates unchanged. The incoming information has broadly confirmed our previous assessment of the medium-term inflation outlook. Inflation is still expected to stay too high for too long, and domestic price pressures remain strong. At the same time, inflation dropped markedly in September, including due to strong base effects, and most measures of underlying inflation have continued to ease. Our past interest rate increases continue to be transmitted forcefully into financing conditions. This is increasingly dampening demand and thereby helps push down inflation.
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.
In any case, we stand ready to adjust all of our instruments within our mandate to ensure that inflation returns to our medium-term targetand to preserve the smooth functioning of monetary policy transmission.
What role did the recent weak economic data and the war in Gaza play in today's discussion? And secondly, did you discuss or at least begin talking about ending PEPP reinvestment earlier or raising banks’ reserve requirements?
Neither of these two questions, neither the PEPP, nor the remuneration of required reserves have been discussed at this meeting. You ask me about the current geopolitical environment and how that has weighed on our decision. I think we repeat two or three times in the context of this monetary policy statement the risks posed by the geopolitical environment and these aggravated risks as we see them unfold and develop. And of course, you have a special sentence in the monetary policy statement (MPS) that refers specifically, in addition to the totally unjustified war of Russia against Ukraine, to the tragic developments as a result of the terrorist attack on Israel. We are monitoring the situation. We are very attentive to the economic consequences that that could have, whether in terms of direct or indirect impact on energy prices, or the level of confidence that economic actors will continue to display.
I have two questions. I think on many peoples’ minds is the question how long is actually “sufficiently long” and what will make you rethink and perhaps cut rates at one point in time? Is it at 2% inflation? Is it at 2.5? Is it at 3? I think that is something the market is interested in. My second question is on your comments about the yields, which are on the rise as well in the euro area and you said from other jurisdictions or from other regions, you are probably referring to the United States. Are you concerned about that rise in yields as well and also about the potential fragmentation here?
So how long is “sufficiently long”? Obviously, we refer to “timely manner”, “sufficiently long”, but in the same breath I say we shall be data dependent. At this point of our fight against inflation and after ten successive hikes, now is not the time for forward guidance. Now is the time to really stick to our data dependency ‘knitting’ if I may say and we shall do so. We have acknowledged on the occasion of this meeting that our assessment is confirmed, the assessment that we had in September. All numbers, if anything, have reinforced our assessment of the situation. We have applied the three criteria that you all know well; the inflation outlook, duly informed by any information that we have, the underlying inflation in all its compositions and the strength of the transmission of monetary policy. So, we will continue to be data dependent.Your second question was essentially when and at what level do you cut? This was not discussed at all, and the debate would be absolutely premature. We have acknowledged in our review of the macroeconomic situation back in September and yet again this time around, and we all know, and you know, that labour cost, wages, profit units – the analysis of that – is critically important to determine the inflation outlook. And we will continue to accumulate data. On labour, for instance, we are going to have a wealth of numbers and data, and intelligence, when collective bargaining agreements and annual negotiations in 2024 will be completed. That is way into 2024. That is only “a for instance.” Even having a discussion on a cut is totally premature. For the moment, what we are saying is that we have to be steady, we have to hold. This is the decision of today. We are holding.Your third question had to do with this sort of external tightening, which is not directly relevant to the fundamentals of the euro area economy, but which are tightening elements nonetheless because they directly impact long-term yields and long-term rates as well. That definitely is a spill over that we take into account and that is compounded with other elements that clearly are bringing inflation down.
You said that you are seeing strong transmission of your past rate increases to financing conditions. Can you say how much of the impact has yet to hit the real economy and then inflation?And then secondly, a follow up on energy costs. I am trying to understand how you would react to another spike in energy costs, for example, as a result of conflict in the Middle East. Would you take the recent inflation episode as a lesson and immediately react to that or could you afford to wait for second round effects?
Interesting questions. I'll start with your second one, which is essentially have we learned anything from the last energy crisis, the impact it has on inflation directly and indirectly, and would we apply the same approach? This is work that is ongoing and that we will continue to do. But it is clear to us that it applies to a completely different economy today and an economy which has had an episode of very high inflation, an economy where the interest rates (on the deposit facility) are at a very high level of 4%, and an economy that has strong employment and which is weakening. We have to take all these factors into account to see how possible higher costs of energy would actually affect both GDP and inflation. And it is in the context of that assessment that we would respond accordingly. But be under no doubt, our determination is intact and our determination to bring inflation to 2% in the medium term is absolutely the same if not reinforced by the proximity of the destination.