The European Central Bank’s monetary policy Against the recent backdrop of high inflationary pressures, the European Central Bank (ECB) has continued with the normalisation of its monetary policy initiated last December. The Governing Council has explicitly expressed its willingness to maintain optionality, gradualism and flexibility in the conduct of monetary policy going forward. In the current climate of uncertainty, this is deemed necessary to allow us to respond to  incoming data to fulfil the ECB’s mandate to pursue price stability and to contribute to safeguarding financial stability. Indeed, the war in Ukraine is increasing the short-term upward inflationary dynamics, adding to the pressures generated by rising energy prices, bottlenecks and the normalisation of demand. The intensification and prolongation of these short-term inflationary pressures make it more likely that second-round effects will emerge and, therefore, that the inflation dynamics will become entrenched in the medium term. However, the war is having an adverse effect on economic growth, which could potentially be significant, particularly in the short term, in a setting where euro area GDP remains below its potential level. Overall, the upside risks to the inflation outlook have intensified, particularly in the near term. Although various indicators of long-term inflation expectations drawn from financial markets and surveys of professional forecasters put inflation at around 2%, there are preliminary signs, which will have to be monitored carefully, of those indicators being revised to above-target levels. In step with the normalisation of monetary policy, net purchases under the pandemic emergency purchase programme (PEPP) were discontinued on 31 March.

We have tried to transpose these challenges to the countries in the region, as in some of them economic boundaries for the monetary policy are lesser compared to the ECB, given positive policy rates. Our simple analysis shows that financial vulnerabilities, observed through the leverage of the public and private sector, seem to be contained, despite the loose financial conditions. Sovereign  17  debt has decreased in the last couple of years, indicating that countries use the benign financial conditions for creating more fiscal space. Private leverage is well below some of the accepted benchmarks. Yet in many of the countries, given the low interest rate environment, household credits are on a rising path, and potential risks are addressed through macro-prudential measures. Hence, some vigilance is needed, with respect to build-up of financial vulnerabilities, though they seem to be much lesser in the region compared to the more advanced economies. Inflation dynamics and its drivers seem to resemble those in the euro area, asking for more profound scrutiny of prices, before proceeding with monetary loosening. At the current juncture, it seems that despite the monetary policy space which exists in part of the region, further policy cuts should be carefully calibrated and considered in the context of country specific assessment of future financial and inflation risks. References: 1. Aleksandra Riedi “Household debt in CESEE economies: a joint look at macro- and micro-level data”, Focus on European Economic Integration, 2019, issue Q1/19. 2. Bank of Spain. 2019.