Governing Council meeting, ECB 15/6/2023

Governing Council meeting, ECB. 15th June 2023

ECB raises rates by a further 0.25%

Emphasising that inflation had remained “too high for too long”, the ECB’s Governing Council raised all three of its key interest rates by a further 0.25% at its meeting on 15^th June. Prices rose by 6.1% in the year to May, a notable reduction on April’s reading of 7% and the lowest rate of inflation since February 2022. Nonetheless, in the words of ECB Christine Lagarde, in the following press conference, “the journey to get there is not over. We will be as restrictive as we need to be to reach our destination.”

This is the eighth 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 400bps to 4% in total - an unprecedented cycle of tightening. Mme Lagarde’s words suggest that the peak of the tightening cycle has not yet been reached. Maturing assets purchased under the 2019 Asset Purchase Scheme have been run off at a rate of €15b. per month since March 2023. As from July, there will be no further reinvestment at all, which should help shrink the ECB’s balance sheet by €25b. per month. No assets purchased under the much larger 2020 Pandemic Emergency Purchase Programme will be run off before the end of 2024, however.

With the Eurozone recording a 0.1% fall in GDP both in the final quarter of 2022 and the first quarter of 2023, this tightening cycle has continued in spite of the 20-nation bloc technically being in a recession. While most commentators are shrugging this off as being of little relevance, anyone who takes a look at the broad money figures will not be so dismissive. Since peaking in September 2022, M3 in the Eurozone has now been on a downward path, falling by €142b. in total thus far, in spite of the positive effects of Croatia’s entry into the single currency bloc at the beginning of 2023. The annual rate of growth has fallen to 1.9%, the lowest level since July 2014, while the annualised quarterly growth rate, which stood at -2.2% in May, has now been negative for five consecutive months. Strong growth in lending by Eurozone banks kept broad money growth buoyant for several months after the termination of the asset purchases but demand for credit is slowing, both from consumers and businesses. Mortgage lending was growing at an annual rate of over 5% at the start of 2022. The most recent figure (May 2023) is 3.1%. Growth in new loans to non-financial companies has declined in the space of six months from 7.3% to 3.8%.

Mme Lagarde emphasised that in her opinion, unit labour costs has been the main driver of inflation which the ECB believes will remain above target throughout 2024. (Wage growth stood at 5.1% in the final quarter of 2022 – the fastest rate of increase since 2009). Ironically, in a speech on 1^st June, she commented on the decline in broad money growth in recent months, but made no comment on its significance. Anyone who places greater importance on changes in broad money when assessing the macroeconomic outlook would reach a different conclusion – in particular, that the decline in broad money growth is likely to get worse and while inflation should fall faster than the ECB predicts, the current “technical recession” is likely to become more serious.