The ECB has practically exhausted its options for tightening monetary policy

The European Central Bank (ECB) at its meeting on Thursday, September 14, again raised interest rates by 25 basis points: now the rate on loans is 4.5%, on deposits – 4%, on margin loans – 4.75%. The increase, which could be the last in the current monetary policy tightening cycle, is explained by the still high level of inflation. In the revised forecast, the ECB actually records the effects of its monetary policy. Given the declining business activity, the regulator does not expect much from the European economy: it is assumed that euro area GDP growth in 2023 will be only 0.7%.

On Thursday, September 14, the European Central Bank raised three key interest rates by 25 basis points. Thus, after the tenth consecutive round of increases, the base rate on loans has been increased to 4.5%, on deposits – to 4%, on margin loans – to 4.75%. The regulator again explained the decision to tighten monetary policy again by the “too high” level of inflation. Let us recall that, according to Eurostat, total annual inflation in the euro area in August, as in July, amounted to 5.3%. The core rate (excluding food and energy prices), as expected, slowed down somewhat: to 5.3% after 5.5% in July. The ECB still expects the indicator to return to the target value of 2% – but, as follows from the macro forecast, not on the horizon of the next two years.

Expectations for annual inflation in the euro area countries were revised upward: to 5.6% (after 5.4% expected in June) for 2023 and to 3.2% (after 3%) for 2024.

The reason is the alarming level of energy prices for the regulator (including rising oil prices, see “Kommersant” from 13 And September 14). For 2025, the forecast was lowered to 2.1% from June’s 2.2%. Core inflation is expected to be 5.1% this year, 2.9% in 2024 and 2.2% in 2025. Although the potentially achievable inflation target of 2% is not mentioned in the forecasts, ECB Chairman Christine Lagarde noted at a press conference following the meeting that keeping rates at the current level will make a “sufficient contribution” to returning inflation to it – although to say that that peak values ​​have already been reached, it is not ready yet.

In her speech, Ms. Lagarde recorded the weakness of the European economy reflected in statistical data and leading indicators and expectations of extremely restrained growth for the year. The ECB’s updated forecast lowers euro area GDP growth estimates: the economy is expected to grow by 0.7% in 2023, 1% in 2024 and 1.5% in 2025. The regulator’s June review assumed growth of 0.9%, 1.5% and 1.6%, respectively.

This decline in estimates actually takes into account the long-term effects of the monetary policy that the ECB has been implementing for the last year, but given the current business activity they look somewhat optimistic.

Let us recall that, as follows from the latest Eurostat data, at the end of July the volume of industrial production in the euro area decreased by 1.1% month-on-month and by 2.2% year-on-year. Analysts expected an annual decline of 0.3% and a monthly decline of 0.7%. The fact that there was no revival of business activity in industry in August is also indicated by the dynamics of the PMI – the indicator was 43.5 points (the 50 point mark separates an increase in activity from a decrease). As Ms. Lagarde emphasized, the post-Covid impulse for growth in services has also exhausted itself. Let us remind you that the PMI in this area in August fell below 50 points (47.9) for the first time since the end of 2022. It should be noted that back in the summer, data on business activity and inflation put multidirectional pressure on the ECB – and therefore, for the first time in a long time, some intrigue remained around the regulator’s meeting until the very end.

The economic recovery of the euro area, which, according to the regulator’s calculations, should have occurred in 2023, is postponed until next year, Ms. Lagarde said. Its prospects continue to be affected by a range of factors, from how strong the European labor market will be to the speed of recovery in other major economies – most notably China.

Kristina Borovikova