The European Central Bank (ECB) maintained its current interest rates during its recent meeting, marking the second consecutive session without changes. Simultaneously, the bank revised its growth projections downward and unveiled strategies to expedite the reduction of its balance sheet.
In response to a notable decline in euro zone inflation, the expectation was widespread that the ECB would leave its policies unaltered. Investors are now closely monitoring signals regarding the potential timing of the first rate cut and assessing the ECB’s plans for balance sheet reduction.
The ECB, in its statement, emphasized that its future decisions will ensure policy rates remain sufficiently restrictive for as long as necessary. However, there was a shift in language concerning inflation, with the ECB now stating that it will “decline gradually over the course of next year” as opposed to the previous characterization of being “expected to remain too high for too long.”
The latest macroeconomic projections anticipate a 0.6% expansion in average real GDP for 2023, down from the earlier forecast of 0.7%. Projections for 2024 have been revised to 0.8% growth from the previous estimate of 1%. The 1.5% projection for 2025 is still in place.
In terms of inflation, the ECB projects an average of 5.4% in 2023, 2.7% in 2024, and 2.1% in 2025. These figures represent adjustments from previous forecasts. The ECB also introduced a new estimate for 2026 at 1.9%.
The ECB emphasized that domestic price pressures, particularly from rising labor costs, remain elevated. Core inflation, excluding energy and food, is expected to average 5% in 2023 and 2.7% in 2024, with subsequent declines in the following years.
Tighter financing conditions were noted to be tempering demand and contributing to inflation control, with the expectation that short-term growth would be subdued before recovering due to increased real incomes and foreign demand.
The ECB’s key interest rate will remain at a record high of 4%. Additionally, the ECB announced the completion of reinvestments under its pandemic emergency purchase program (PEPP) by the end of 2024. The gradual transition includes a monthly reduction of the PEPP portfolio by an average of 7.5 billion euros over the second half of 2024.
Euro zone inflation, having moderated from 10.6% in October 2022 to 2.4% in the most recent reading in November, brings the ECB’s 2% target within reach. This has fueled expectations of potential rate cuts in the coming year.
ECB President Christine Lagarde emphasized the central bank’s data-dependent approach during a news conference. Despite the flattening path to reach the inflation target, Lagarde highlighted the need to remain vigilant, especially considering potential risks from domestic inflation.
Following the ECB’s announcement, European exchanges and the euro experienced gains. The market movements were influenced by the U.S. Federal Reserve’s decision to hold rates steady and the Bank of England’s subsequent rate hold, both contributing to expectations of a dovish stance among major central banks.
