Luis de Guindos: The economic outlook and monetary policy in the
euro area
Speech by Mr Luis de Guindos, Vice-President of the European Central Bank, at the
14th edition of Spain Investors Day, Madrid, 10 January 2024.
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Over the past two years, economic developments in the euro area have been shaped
by the easing of pandemic-related supply constraints and by the energy price shock in
the wake of the Russian invasion of Ukraine. Before that, inflation had been low and
monetary policy accommodative, but the surge in inflation to unprecedented levels in
2022 prompted the ECB to normalise and tighten monetary policy. In December 2021
we announced a gradual reduction in our asset portfolio and in July 2022 we increased
our key interest rates for the first time in 11 years. This was followed by nine
consecutive hikes that raised interest rates by a total of 450 basis points by September
last year. In 2023 a lot of progress was made in curbing inflation. However, more needs
to be done to ensure a timely and sustainable return of inflation to our 2% medium-term
target.
In my remarks today I will provide an overview of the latest economic developments
and the rationale behind the monetary policy decisions that we took in December. I will
then discuss the outlook for the euro area economy for the coming months.
Inflation
2023 ended with an inflation rate of just below 3% in December, which was good news.
The uptick from November was widely expected, reflecting base effects and the
withdrawal of energy support measures. Euro area inflation had been above 10% in
October 2022 and at 8.6% at the start of 2023. The decline in 2023 affected all the main
components of headline inflation, confirming a broad-based disinflationary process that
gained momentum in the second half of the year.
Food inflation has declined substantially from its peak of over 15% in March 2023, but
remained high at just above 6% in December. Energy inflation remained deep in
negative territory in December, recording the eighth consecutive decline since May
2023.
Another important aspect is that core inflation entered a clear downward trajectory,
continuing to decline to 3.4% in December. Services prices have been slower to
recede, but they fell sharply in November and remained stable in December. Taken
together, these trends reflect the indirect effect of falling energy prices, the easing of
supply bottlenecks and the increasing pass-through of our monetary policy tightening to
demand. However, high wage pressures, the outcome of upcoming wage negotiations
and intensifying geopolitical tensions add on uncertainty around the future path of
inflation.
The rapid pace of disinflation that we observed in 2023 is likely to slow down in 2024,
and to pause temporarily at the beginning of the year, as was the case in December
2023. Positive energy base effects will kick in and energy-related compensatory
measures are set to expire, leading to a transitory pick-up in inflation, similar to what
has happened with Spanish headline inflation in recent months. Inflation in Spain
peaked in July 2022, reaching 10.7%, and disinflation set in earlier than in other euro
area countries, with the rate coming down to 1.6% in June 2023. Since then, the large
drop in energy prices has fallen out of the calculation and inflation increased by an
average of 3% between July and December.
Economic activity
By contrast, growth developments are more disappointing. Economic activity in the euro
area slowed slightly in the third quarter of 2023. Soft indicators point to an economic
contraction in December too, confirming the possibility of a technical recession in the
second half of 2023 and weak prospects for the near term. The slowdown in activity
appears to be broad-based, with construction and manufacturing being particularly
affected. Services are also set to soften in the coming months as a result of weaker
activity in the rest of the economy.
The labour market continues to be particularly resilient to the current slowdown. The
euro area unemployment rate stood at 6.4% in November, broadly unchanged from
October and close to its historical low.
However, we are seeing the first signs of a correction taking place in the labour market.
The latest data on total hours worked show a slight decline in the third quarter, the first
since the end of 2020. This is mainly driven by the reduction in the average hours
worked offsetting the increase from the rise in employment. The continuous decline in
job vacancy rates, which marginally decreased again in the third quarter, suggests that
the ongoing labour market adjustment may also weigh on the number of jobs.
Financial and monetary conditions
With regard to financial and monetary conditions, our past interest rate increases
continue to be transmitted strongly to financing conditions, with lending rates for
business loans essentially unchanged in November, at over 5%, and mortgage rates
increasing to 4%. The tight financing conditions are propagating through the economy,
dampening demand and helping to push down inflation.
Before taking its December decisions, the Governing Council closely considered their
implications in terms of fragmentation risk and financial stability. Government bond
markets are stable, sovereign yield spreads have been resilient to the normalisation of
the Eurosystem's balance sheet, and investors have been able to absorb the extra
securities released by the reduction in the asset purchase programmes. Euro area
banks have proven resilient, boasting comfortable levels of capital and strong
profitability which make them well equipped to withstand adverse shocks. Despite these
strong fundamentals, bank valuations remain compressed, pointing to concerns about
the long-term sustainability of bank earnings amid weak growth prospects, increased
downside risks from deteriorating asset quality, lower lending volumes and higher
funding costs. Direct and indirect links between banks and the lightly regulated
nonbank financial sector also pose risks to the financial system as a whole and highlight the
need to boost non-bank resilience going forward. The overall outlook thus calls for
vigilance and macroprudential policy remains the first line of defence against the
buildup of financial vulnerabilities.
Monetary policy
At its December meeting the Governing Council decided to keep the three key ECB
interest rates unchanged. This decision was based on the overall assessment of the
economic and inflation outlook, as well as the effects of our monetary policy. We
believe that the current level of interest rates, maintained for a sufficiently long duration,
will make a substantial contribution to the timely return of inflation to our target.
At the last meeting we also decided to advance the normalisation of our balance sheet.
We intend to continue to reinvest in full the principal payments from maturing securities
purchased under the pandemic emergency purchase programme (PEPP) during the
first half of 2024. Over the second half of 2024, the PEPP portfolio will decline by €7.5
billion per month on average. We discontinued asset purchase programme
reinvestment of redemptions in July 2023 and we expect to discontinue the
reinvestments under the PEPP from 2025.
The key ECB interest rates are our primary tool for setting the monetary policy stance.
Our future decisions will continue to follow a data-dependent approach to determining
the appropriate level and duration of restriction.
Conclusion
The events of the last two years have significantly shaped economic developments in
the euro area, pushing up inflation to levels not seen since the introduction of the euro.
In response, we started a gradual reduction in our asset portfolio and we increased our
policy rates by a total of 450 basis points. Our strong reaction was key to prevent a
deanchoring of expectations and to curb inflation. In terms of economic activity, the
slowdown has so far been contained and gradual. However, the incoming data indicate
that the future remains uncertain, and the prospects tilted to the downside.
The inflationary shock that we were confronted with following the energy crisis has been
particularly challenging: it occurred in an already difficult environment, with the world
economy recovering from the pandemic and global supply chains still disrupted.
Furthermore, supply side shocks are particularly difficult to manage using monetary
policy instruments. In this context, sustainable and investment-oriented fiscal policies
aimed at promoting the energy transition, strengthening the resilience of supply chains
and increasing euro area productivity are supportive of our price stability goal.
Structural reforms and investments to enhance the euro area's supply capacity can help
reduce price pressures in the medium term.
In this regard, we very much welcome the agreement on the EU's economic
governance framework reached a few weeks ago. It is a powerful signal to markets as it
reduces uncertainty about fiscal rules in the EU. The reformed framework will help
strike a balance between sustainable public finances and sufficient debt reduction on
the one hand and room for reforms and investment on the other, while supporting
countercyclicality of fiscal policies. Achieving this balance turned out to be less
straightforward than we might have hoped. It is now crucial that the new fiscal
framework is implemented properly and without delay.
Thank you for your attention.