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 5  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.

Realised real rates – calculated as observed nominal rates minus the realised inflation rates – have also declined, and have been substantially lower in the 2000s than in the 1980s (chart 3). There are several potential explanations for this development. A first explanation is the “global savings glut” hypothesis, which states that the decline in real interest rates was the result of an increase in savings from emerging economies and oilproducing economies. It is argued that this increase was driven by, among other things, an accumulation of foreign exchange reserves, elevated oil prices and precautionary savings (chart 4).2 But the decline in real rates could also result from a decrease in growth prospects – itself caused, for instance, by a decline in the growth of productivity or population, or by demographic shifts, particularly a reduction in the working population relative to the nonworking population (charts 5 and 6).3 None of these possible explanations for the reduction in real interest rates has been fully confirmed, and therefore they do not constitute a sound basis for forecasting future interest rate developments. But the discussion highlights the fact that, in order to understand longerterm trends in real interest rates, we have to rely on low frequency changes in fundamental economic factors, while monetary policy does not play a primary role here. The cyclical downturn Let us now turn to more recent interest rate developments. As mentioned, since the financial crisis and the global economic slump that followed, we have seen a further fall in rates to very low levels.