Governing Council meeting, ECB 14/09/2023

Governing Council meeting, ECB. 14^th September 2023

ECB raises rates by a further 0.25%

The ECB’s Governing Council raised all three of its key interest rates by a further 0.25% at its meeting on 14^th September in what can be described as a dovish hike. This is the tenth back-to-back increase in the cost of borrowing in the space of less than a year, with the main refinancing fixed rate having now risen by 450bps to 4.5% in total – a 22-year high and an unprecedented cycle of tightening.

Consumer price inflation stood at 5.3% in the year to August, unchanged on July’s reading. Energy prices are continuing to decline, albeit at a slower rate than during June. The core inflation rate (excluding food and fuel prices) fell from 5.5% to 5.3% and prices at the factory gate (the producer price index), which first turned negative in May, fell by no less than 7.6% in the year to July. ECB President Christine Lagarde insisted that the ECB was committed to returning inflation to its 2% target, but the press release which followed the Governing Council’s meeting suggested that it believes that the cost of borrowing has now been hiked to a sufficient level eventually to bring inflation down to target, given the lags associated with the transmission of monetary policy. As maturing assets purchased under the 2019 Asset Purchase Scheme are no longer being reinvested, the ECB’s balance sheet should continue to shrink, theoretically by as much as €25b. per month. Although in theory, no assets purchased under the much larger 2020 Pandemic Emergency Purchase Programme will be run off before the end of 2024, the ECB stated that “the Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.

The press release is quite unapologetic about its objective of dampening demand in order to bring inflation back to target.  Eurozone GDP increased by a modest 0.1% in both quarters of 2023 so it will not take much to tip the 20-nation bloc into recession. Demand for credit is already slowing, both from consumers and businesses. Mortgage lending was growing at an annual rate of 3% in April. July’s figure was a mere 0.8%. In the same period, growth in new loans to non-financial companies declined from 3.8% to 1.7%. Only ten months ago, this figure was 7.3%. At least the spread in bond yields is much narrower compared with the sovereign debt crisis, with less than 200bps separating Germany from Greece and Italy. This, however, is primarily caused by the weakness of the German economy. The stock market has also been on a generally downward trend recently after increasing by 17.2% between January and July.  

Broad money contracted by 1.7% in the three months to July and the annual growth rate also turned negative for the first time since April 2010 after a fall of €60b. during the month. These numbers suggest that the downturn could be deeper and more protracted than the ECB expects. It has lowered its economic growth projections significantly, with annual GDP growth expected to come in at 0.7% in 2023 and 1.0% in 2024. Even this, however, could turn out to be wildly optimistic.