profits, restrictive monetary policy is reducing firms'pricing power and weighing on unit profits, which is slowing the pass - through of wages to prices. in fact, unit profit growth fell to 2. 5 % in the last quarter of 2023, down from a peak of more than 9 % in the last quarter of 2022. while we expect inflation to return to our 2 % target next year, the outlook is surrounded by substantial risks. the geopolitical situation, especially in the middle east, poses a particular upside risk to inflation. while growing tensions in the region initially triggered only moderate movements in oil prices, recent developments remind us that monitoring 1 / 3 bis - central bankers'speeches such risks and their impact on commodity prices remains highly relevant for our inflation outlook. should tensions in the region escalate further, major trading disruptions and impediments to oil supplies could push up energy prices and freight costs in the near term, disrupting global trade. inflation could also turn out higher than anticipated if wages increase more than expected or if profit margins prove to be more resilient. by contrast, a stronger - than - expected dampening impact of monetary policy on demand or an unexpected worsening of the economic environment in the rest of the world may result in downside surprises in inflation. economic activity growth is expected to resume at a moderate pace. the latest economic indicators suggest that activity is gradually recovering after a period of stagnation. but there are notable differences across sectors. production in manufacturing continues to put a drag on activity. in the first two months of 2024 industrial production was still 1. 5 % below the average level in the final quarter of 2023. by contrast, services activity offers a silver lining, as it is likely to have picked up again since the turn of the year. services production rose by 1. 5 % in january, which is the highest reading since may 2023. survey information confirms the diverging paths between manufacturing and services. the manufacturing output purchasing managers'index ( pmi ) has remained well in contractionary territory for some time while the pmi for services has been improving since october last year, returning to expansionary territory in the first quarter of 2024. although we will have to wait and see to what extent the encouraging signs of a pick - up in the services sector will be reflected in the hard data for the first quarter of the year, they do lend support to the assessment we provided in our march projections. ecb staff

a. mian, k. rao and a. sufi ( 2011 ), “ household balance sheets, consumption, and the economic slump ”, chicago booth working paper, november. bis central bankers ’ speeches the repo rate is a blunt instrument for dealing with financial imbalances we have seen that there are risks in sweden linked to household debt, but is the repo rate really the best tool to deal with them? it is obvious that the repo rate affects the supply of credit in the economy. when one discusses the effects of the repo rate on the economy, one usually talks about the interest rate channel, the credit channel and the exchange rate channel. the interest rate channel means, to put it simply, that it becomes more attractive to borrow than to save when the interest rate is cut, and vice versa. the credit channel has an impact through asset prices, for instance, house prices, rising when the interest rate is cut. this means that the value of the collateral for the loan increases, which pushes up the banks ’ lending. the exchange rate channel means that a lower interest rate tends to weaken the exchange rate and contribute to higher import prices. to the extent that the real exchange rate also weakens, it contributes to an increase in net exports, as the relationship between export and import prices changes. 3 two of the three channels for monetary policy thus have an impact by affecting demand and supply with regard to credit in the economy. one sometimes also talks about a fourth channel ; the risk - taking channel, which means that a lower interest rate contributes to the banks increasing their risk - taking when lending. 4 all in all, it is clear that monetary policy has an effect on household debt and asset prices, although it can be difficult to determine exactly how large and how lasting this effect is. we have limited experience of low interest rates over longer periods of time. there is a clear risk that the current low interest rates will encourage greater indebtedness than is reasonable in a long - run perspective. but, at the same time, the interest rate is a blunt instrument to manage the risks linked to household debt and house prices. one reason for this is that an adjustment in the interest rate also affects the economy through the exchange rate channel, which has further effects on inflation and the real economy. but the impact of the interest rate can also be too broad in other ways, such as when one wishes to slow down household borrowing but not corporate investment. a higher interest rate aimed