The Governing Council of the ECB today confirmed the expectations of one reduction in interest rates by a quarter of a pointgiving a turning point to monetary policy, after the last rate increase which took place in September 2023. The Board has in fact decided to reduce by 25 basis points the three reference interest rates, taking into account the most recent inflation and growth prospects and the intensity of monetary policy transmission.
The decisions taken by the Board
The ECB's governing council decided to reduce rates by 25 basis points, bringing the rate to main refinancing operations at 4.25%, that on marginal refinancing operations at 4.5% and that on deposits at 3.75%, effective June 12, 2024.
The Board of Directors then took note that the Quantitative easing plan (PAA) is shrinking at a measured and predictable pace, given that the Eurosystem no longer reinvests the capital repaid on maturing securities, while confirming that will continue to reinvest the capital reimbursed in full on the securities maturing within the framework of the Pandemic Plan (PEPP) until the end of June 2024. In the second half of the year it will reduce the PEPP portfolio by an average of €7.5 billion per month in order to finish reinvestments under that program at the end of 2024.
As for longer-term refinancing operationsagainst the reimbursements of the amounts received from the banks, the Governing Council will regularly review how targeted operations and ongoing reimbursements contribute to the stance of monetary policy.
The reasons for the decision
In making the decision to cut rates, the Board members believed that it was “it is appropriate to moderate the degree of restriction of monetary policy” after nine months of unchanged interest rates. And this happened on the basis of the consideration that, from the September 2023 meeting, inflation fell by more than 2.5 percentage points and the inflation outlook has improved markedly. Core inflation also fell, reinforcing signs of easing price pressures, and inflation expectations declined across all horizons.
There monetary policy has kept financing conditions restrictive. By curbing demand and ensuring that inflation expectations remain well anchored, this contributed significantly to the reduction of inflation.
At the same time, despite the progress made in recent quarters, strong pressures persist internal prices since the wage growth remains high. As such, inflation is expected to likely remain above target until much of next year.
The new projections of economists
The latest projections formulated by Eurosystem experts for inflation overall and underlying projections have been revised upwards for 2024 and 2025 compared to the March projections. Experts now indicate that overall inflation will level off averaging 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026. Inflation net of the energy and food component will average 2.8% in 2024, 2.2% in 2025 and 2% in 2026.
At the same time, it is expected that the economic growth increases progressively over the three-year period, stabilizing to 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026.
Next decisions
The Board of Directors is determined to ensure the timely return of inflation to its 2% target in the medium term and to preserve the orderly functioning of the monetary policy transmission mechanism. For this reason he assures that “it will keep the reference rates at sufficiently restrictive levels for as long as necessary to achieve this aim”.
To determine the appropriate level and duration of the restriction, the Governing Council will continue to follow a data-driven approach on the basis of which the decisions are defined from time to time at every meeting. In particular, interest rate decisions will be based on its assessment of the inflation outlook, given new economic and financial data, the dynamics of underlying inflation and the intensity of monetary policy transmission, without being tied to a particular path of rates.
“The instrument for protecting the monetary policy transmission mechanism – it is stated – can be used to counteract unjustified, disorderly market dynamics that seriously jeopardize the transmission of monetary policy in all euro area countries, thus allowing the Governing Council to fulfill its price stability mandate more effectively.”
