Christine Lagarde: IMFC statement
Statement by Ms Christine Lagarde, President of the European Central Bank, at the
forty-eight meeting of the International Monetary and Financial Committee (IMFC), IMF
Annual Meetings, Marrakech, 14 October 2023.
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Introduction
Following the devastating earthquake in Morocco, I wish to express my heartfelt
solidarity with the Moroccan people as well as with the victims of other recent natural
disasters.
Although the global economic outlook has remained broadly the same since our
previous meeting in April, growth prospects across major economies have been
changing, with the outlook for major advanced economies proving more resilient than
expected. However, the recovery prospects for the global economy remain fragile amid
persisting geopolitical tensions, stemming in particular from Russia's invasion of
Ukraine, rising trade fragmentation and the possibility of renewed financial sector
stress. Global headline inflation is receding, but underlying inflationary pressures
remain persistent as labour markets continue to be tight.
The ECB is determined to ensure that inflation returns to its 2% medium-term target in a
timely manner. In order to reinforce progress towards the target, the Governing Council
decided at its September meeting to raise the key interest rates by 25 basis points,
bringing the total rate increase since July 2022 to 450 basis points. Moreover, as of July
this year, the Eurosystem is no longer reinvesting principal payments from maturing
securities under the asset purchase programme. On the basis of our latest assessment,
we consider that our key interest rates have reached 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. We will continue to
follow a data-dependent approach to determining the appropriate level and duration of
restriction.
Economic activity
The euro area economy has slowed markedly over the past year. Having broadly
stagnated over the first half of this year, real GDP is expected to remain subdued in the
coming months. Incoming data suggest that activity has been weak in the third quarter,
as slower global demand and the impact of tighter financing conditions weigh on
growth. Manufacturing continues to suffer, while the services sector, having shown
resilience in the first half of the year, has now also started to weaken. Economic
momentum should pick up over time, as falling inflation and higher wages will
increasingly support real incomes and lead to renewed growth in consumer spending.
On the labour market, the unemployment rate was at a record low in July and
employment growth remained resilient in the first half of the year, albeit that momentum
is slowing.
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 an even stronger monetary policy response. Fiscal
policies should be designed to make our economy more productive and to gradually
bring down high public debt. Policies to enhance the euro area's supply capacity, such
as high-quality public investment and structural reforms, can help reduce price
pressures in the medium term, while supporting the green transition.
Risks to the outlook continue to be tilted to the downside. Growth could be slower if the
effects of monetary policy turn out to be more forceful than expected, or if the world
economy weakens further and geopolitical risks intensify. On the other hand, growth
could also be higher than projected if the strong labour market, rising real incomes and
receding uncertainty boost confidence among consumers and businesses and lead
them to spend more.
Inflation
Since peaking in October 2022, euro area headline inflation has more than halved. The
decline is broad-based across the main components of inflation and reflects falling
energy commodity prices, the easing of supply bottlenecks and the impact of tighter
monetary policy. Core inflation remains at elevated levels, reflecting the fact that the
fading impact of the past surge in input costs is being counterbalanced by rising labour
costs. Indeed, employees demanding compensation for the loss in purchasing power
amid tight labour markets has resulted in historically high wage growth. We expect euro
area inflation to continue to decrease, owing to easing cost pressures as well as the
impact of tighter monetary policy. Wage growth is expected to decline gradually, albeit
remaining high over the projection horizon, driven by increases in minimum wages and
inflation compensation in a context of tight, though cooling, labour markets. Profit
margins, which expanded notably last year, are expected to provide some buffer to the
pass-through of labour costs to final prices in the medium term. Inflation is expected to
decline to levels close to 2% in 2025. However, the downward path has risks in both
directions. Upside risks stem from renewed upward energy and food cost pressures, a
de-anchoring of inflation expectations above our target, and higher than anticipated
increases in wages or profit margins. The downside risks include weaker demand, due
for example to a stronger transmission of monetary policy or to a worsening of the
international economic environment.
Euro area banking sector, non-bank financial intermediation and
financial stability
The euro area financial system has shown resilience in the face of weakening growth
prospects and continued high inflation. Financial stability concerns are shifting from the
immediate impact of rapidly increasing interest rates and related asset price
movements to the more medium-term and gradual effects of tighter financial conditions
for financial and non-financial sectors.
Banking sector profitability has so far benefited, in aggregate, from the higher interest
rate environment. Banks continue to hold sizeable liquidity buffers and have further
improved their capital position. Asset quality remains robust, although early signs of
deterioration are becoming visible. Micro- and macroprudential policies and supervision
have contributed to the resilience of the banking system, with our recent stress test
showing that banks could withstand a severe economic downturn. Banks should
nonetheless remain attentive to asset quality, liquidity and funding risks, and exercise
prudent and forward-looking risk management. Moreover, banks need to have credible
strategies to advance their business models, considering in particular the digitalisation
of financial services. Governance and risk management frameworks should keep pace
with the acceleration of climate-related financial risks. Looking ahead, maintaining
resilience in the euro area financial system remains a priority for macroprudential policy,
as capital buffers limit potential consequences of shocks.
Despite the recent portfolio de-risking, credit and liquidity risks in the non-bank financial
institutions (NBFI) sector continue to be elevated. NBFIs thus remain vulnerable to
asset price corrections amid macroeconomic uncertainty, volatile markets and a turning
of the real estate cycle. Several types of investment funds, including real estate funds,
show sizeable mismatches between asset liquidity and redemption terms. Additionally,
some NBFIs exhibit material leverage on and off the balance sheet. An important
lesson from recent market shocks is the need to significantly boost the resilience of the
NBFI sector. This requires a comprehensive strengthening of the policy framework for
non-banks, including from a macroprudential perspective, in an internationally
coordinated manner.
Supporting global cooperation
We welcome the good progress Ukraine has made on its programme under the IMF's
Extended Fund Facility. In view of the prolonged war, continued support for Ukraine by
the IMF and the international community is crucial. On Ukraine's side, strong ownership
and reform momentum will need to be maintained to pave the way for the programme's
success and to support reconstruction efforts.
Amid increasing fragmentation dynamics, international cooperation is more important
than ever. We support a strong IMF at the centre of the global financial safety net. A
solid capital position is a precondition for the IMF to be able to appropriately support its
members, particularly the most vulnerable ones. We welcome the spirit of compromise
which enabled the conclusion of the review of IMF precautionary instruments, given
their important role in crisis prevention. Going forward, the impact of the expanded
access by countries to IMF resources should be closely monitored, while the signalling
effect of precautionary instruments should be retained.
EU Member States and central banks are playing their part in the IMF and in the recent
drive for resources. With pledges of more than USD 31 billion, they have made a
significant contribution and lead the way in transferring resources to IMF Trusts
(Poverty Reduction and Growth Trust and Resilience and Sustainability Trust).
Geoeconomic tensions have increased in recent years, in particular with Russia's
invasion of Ukraine. These tensions may result in a regionalisation of international trade
and value chains. Trade fragmentation could be damaging to the global economy,
reducing efficiency in the allocation of resources, hindering diffusion of innovations and
limiting access to external financing. Ultimately, global production could be lower and
prices higher - to the detriment of the poorest. Geopolitical tensions could also lead to
foreign direct investments segmenting along geopolitical lines and global payment
systems becoming more fragmented, thus reversing some of the gains from financial
integration. This would not only reduce global risk sharing but also limit opportunities for
channelling funds towards investments needed to mitigate and adapt to climate change.
In view of these risks, multilateral cooperation remains essential.
This also holds true for filling the investment gap to achieve international climate goals
as there will be high social costs if we get the green transition wrong. Large
crossborder investment flows are needed, which requires further convergence and accurate
assessment of national and international frameworks. In addition, we need to create an
environment in which climate finance is levelled up steeply to fund the transition, and in
which public finance works as a catalyst for increased private capital flows. The EU is
working towards those objectives and has enshrined both a long-term net-zero goal
with the European Green Deal as well as medium-term targets with its "Fit for 55"
package. Our second economy-wide climate stress test has recently shown that a
delayed or late-push transition would negatively affect banks' credit risk, which would
rise by more than 100% by 2030 compared with 2022. In an accelerated transition, on
the other hand, this increase would be 40% lower.