ECB Meeting Wrap – December 2023

In a week filled with central bank meetings, the ECB took center stage yesterday. In a widely anticipated decision, the ECB announced its choice to maintain the key interest rates at their current level, marking the second consecutive meeting in which the ECB has opted for unchanged interest rates. As said a while ago, the hiking cycle initiated in July 2022 has reached its conclusion.

Despite a slowdown in inflation in the Eurozone to 2.4% in November, following a peak of around 10% last year, the ECB cautioned against interpreting this deadline too optimistically. Indeed, the bank noted that inflation might experience a temporary rise in the near term due to persistent domestic price pressures, primarily attributed to robust growth in unit labor costs.

Looking at the statement, it appears largely unchanged. However, one noteworthy change suggests that the duration implied by “sufficiently long” may not be as extended as previously thought: the opening line of the statement, which previously asserted that inflation is “still expected to remain too high for too long” has been removed, signaling a subtle shift in the ECB’s perspective.

Indeed, the central bank has forecasted a deceleration in consumer price growth to its 2% target within the next three years, thereby overcoming a crucial barrier for considering rate cuts. However, Lagarde emphasized a more stringent approach, saying that policymakers would be “a little more severe”, aiming to achieve this milestone by 2025 already. The ECB’s projections indicate an expectation of headline inflation averaging 5.4% in 2023, 2.7% in 2024, 2.1% in 2025, and 1.9% in 2026. Notably, the figures for 2023 and 2024 have been revised downward from September’s forecasts.

Despite these adjustments, policymakers reiterated their commitment to maintaining borrowing costs at “sufficiently restrictive levels for as long as necessary”. Lagarde went a step further by dispelling market expectations of an early rate cut in March, emphasizing the need to remain vigilant against inflationary pressures and explicitly stating that the governing council did not entertain discussions about rate cuts yet. However, she also hinted at a data-rich first half of the next year, suggesting that any move is unlikely before June or July.

Nevertheless, it’s evident that this stance is a strategic bluff. The European economy is currently in a weak spot and may struggle to sustain such elevated rates for an extended period. Underscoring the economic challenges, the ECB revised downward growth forecasts for 2023 from 0.7% to 0.6%, and for the next year as well from 1.0% to 0.8%. Additionally, the weak PMI numbers from France and Germany this morning affirm once again the fragility of the economy. While a rate cut in Q1 may seem premature, it would be unwise to discount the possibility given the underlying economic conditions.

The most noteworthy decision of the meeting, however, lies in the acceleration of the timeline for commencing the wind-down of the PEPP, succumbing to the insistence of more hawkish members within its governing council to stop asset purchases sooner than initially expected. The ECB has indeed announced its intention to allow the €1.7 trillion portfolio to taper off at an average rate of €7.5 billion per month throughout the second half of the upcoming year. Furthermore, it will cease all reinvestment of maturing bonds by the end of that year, deviating from the earlier commitment by the ECB to reinvest principal repayments in the PEPP portfolio until at least the end of 2024.

In any case, while the balance sheet holds a certain degree of significance, it is crucial to remember that the primary monetary policy tool remains interest rates. Decisions on this front are made independently of developments within the PEPP framework, so one should not read too much into the decision.