EU Relaxes Monetary Policy as Growth Concerns Rise

Image Credit: European Central Bank

June 6, 2024/European Central Bank

The Governing Council decided to lower the three key ECB interest rates by 25 basis points. Based on an updated assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission, it is now appropriate to moderate the degree of monetary policy restriction after nine months of steady holding rates. Since the Governing Council meeting in September 2023, inflation has fallen by more than 2.5%, and the inflation outlook has improved markedly. Underlying inflation has also eased, reinforcing that price pressures have weakened and inflation expectations have declined at all horizons. Monetary policy has kept financing conditions restrictive. Dampening demand and keeping inflation expectations well anchored has significantly contributed to bringing inflation back down.

At the same time, despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year. The latest Eurosystem staff projections for both headline and core inflation have been revised for 2024 and 2025 compared with the March projections. Staff now see headline inflation averaging 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026. For inflation, excluding energy and food, staff project an average of 2.8% in 2024, 2.2% in 2025 and 2.0% in 2026. Economic growth is expected to rise to 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026.

The Governing Council is determined to promptly ensure inflation returns to its 2% medium-term target. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim. The Governing Council will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction. Its interest rate decisions will be based on assessing the inflation outlook in light of the incoming economic and financial data, underlying inflation dynamics and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

The Governing Council also confirmed it would reduce the Eurosystem’s securities holdings under the pandemic emergency purchase programme (PEPP) by €7.5bn per month on average over the year’s second half. The modalities for reducing the PEPP holdings will broadly align with those followed under the asset purchase programme (APP).

Key ECB Interest Rates

The Governing Council decided to lower the three key ECB interest rates by 25 basis points. Accordingly, the interest rates on the main refinancing operations, the marginal lending facility, and the deposit facility will decrease to 4.25%, 4.50%, and 3.75%, respectively, from June 12, 2024.

Asset Purchase Programme (APP) and Pandemic Emergency Purchase Programme (PEPP)

The APP portfolio is declining at a measured and predictable pace as the Eurosystem no longer reinvests the principal payments from maturing securities.

The Governing Council will continue to reinvest, in full, the principal payments from maturing securities purchased under the PEPP until the end of June 2024. Over the second half of the year, it will reduce the PEPP portfolio by €7.5bn per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.

The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio to counter risks to the monetary policy transmission mechanism related to the pandemic.

Refinancing Operations

As banks repay the amounts borrowed under the targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted lending operations and their ongoing repayment contribute to its monetary policy stance. The Governing Council is ready to adjust all its instruments within its mandate to ensure that inflation returns to its 2% target over the medium term and preserve the smooth functioning of monetary policy transmission. Moreover, the Transmission Protection Instrument is available to counter unwarranted, disorderly market dynamics that seriously threaten monetary policy transmission across all euro area countries, thus allowing the Governing Council to deliver on its price stability mandate more effectively.

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