Outlook For Inflation and Growth
The Eurozone finds itself in the midst of a declining economic period, and all signs point to this trend persisting in the foreseeable future. Several factors contribute to this sluggishness, chief among them being the weakening demand for European exports and the challenging financing conditions faced by businesses. These dynamics are taking a toll, notably over the manufacturing and service sectors, where growth has stagnated.
The ECB has made downward revisions to its inflation projections, specifically excluding energy and food prices. In 2023, the average inflation rate is expected to be 5.1%, followed by 2.9% in 2024 and 2.2% in 2025. This adjustment can be attributed to a combination of factors, primarily the tightening of financing conditions, which is partly reflective of the ECB's own policy measures and the subdued economic outlook plays a crucial role in shaping these inflation expectations.
In the face of persistent inflation concerns, although inflation is on a declining trajectory, there is a prevailing expectation that it will remain elevated for an extended period. The ECB is committed to promptly realign inflation with its medium-term target of 2%, and they raised interest rates by 25 basis points during their September meeting. From my perspective, the ECB's interest rates have now reached levels that, if maintained over a considerable period, will significantly contribute to a timely return of inflation to the medium-term target
Monetary Policy
In order to understand the decisions that the ECB has taken, it is crucial to understand both sides of monetary policy transmission. On one side, we have the impact of monetary policy in banking and financial markets. We can notice that this transmission is almost done following the significant decrease in demand for credit. Due to the ECB’s policies, the financial conditions of the banking sector have tightened. ECB has been reducing the TLTRO from €2.1 trillion to €500 million, and it is expected to be close to 0 by 2024. To reach price stability, it is important to reduce the liquidity introduced by the ECB in recent years.
”Starting to talk about rate cuts now is premature. Still, I think the last stretch is going to be more difficult. We are on our way towards 2%, but we must monitor that very closely” - Luis De Guindos, ECB Vice-President.
On the other hand, we have the uncertain effect of contractionary policy in the real economy. Even though economic activity has slowed down, additional factors may have contributed to it, like the increment in oil prices or a weaker euro.
Despite some remaining uncertainties concerning the transmission of the ECB's contractionary monetary policies, the institution remains firm in its data-driven approach. Given the challenging macroeconomic environment, this approach is designed to ensure that these policies have the intended effect on financing conditions, the real economy, and inflation. As an attempt to bridge knowledge gaps and assist policymakers, the ECB has established a policy framework that can withstand the complexity and unpredictability of the current economic landscape. Their future decisions are based on three primary criteria: the inflation outlook, the underlying inflation dynamics, and the strength of monetary policy transmission.
It is essential to emphasize that historical data-based assessments should always be complemented with analyses of the current economic and financial circumstances. History has demonstrated that unexpected events such as geopolitical tensions or pandemics can radically alter the macroeconomic landscape over the long term. As the Eurozone navigates these challenging economic waters, the ECB's strategies and policies play a crucial role in shaping the region's economic future.
Written by: Alejandro Bravo
Comments