In a highly anticipated decision, the European Central Bank (ECB) has opted to keep its key interest rates unchanged, signaling a commitment to its current monetary policy stance. The decision comes as the Governing Council grapples with persistent headline inflation and evolving economic conditions. Therefore, the ECB’s focus remains on steering inflation back to its medium-term target of 2 percent from its current level of 2.9 percent. Hence, the ECB emphasized the importance of sustained restrictive interest rates.
Inflation outlook
The ECB’s decision relied on the incoming economic information. This broadly confirmed the central bank’s previous assessment of the medium-term inflation outlook. Although there’s a temporary rise in headline inflation due to energy prices, the ongoing decrease in core inflation and the effects of past ECB interest rate hikes are keeping financial conditions tight. However, this reduces demand and puts further pressure on lowering inflation.
The Governing Council expressed its determination to ensure that inflation returns to its 2 percent medium-term target promptly. It believes that the current key ECB interest rates if maintained sufficiently, will make a substantial contribution to achieving this goal. Therefore, the central bank underscored a commitment to keeping policy rates at restrictive levels for as long as necessary to support the inflation target.
Market reaction
Following the ECB’s interest rates announcement, the euro traded marginally higher against the U.S. dollar and the British pound. Meanwhile, European stocks experienced minimal changes. However, European bond yields were slightly lower. The market reaction reflected investors’ expectations for limited fresh guidance from the ECB.
Data-dependent approach
The ECB remains committed to a data-dependent approach in determining the appropriate level and duration of policy restrictions. Therefore, ECB interest rate decisions will depend on the assessment of the inflation outlook. They will also take into account economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.
Moreover, ECB interest rates on the main refinancing operations, marginal lending facility, and deposit facility will remain unchanged at 4.50 percent, 4.75 percent, and 4.00 percent, respectively. Hence, the central bank deems these levels as essential for achieving its inflation target.
Asset Purchase Program (APP) and PEPP
The APP portfolio is gradually declining, with the Eurosystem no longer reinvesting principal payments from maturing securities. Regarding the pandemic emergency purchase program (PEPP), the Governing Council plans to reinvest the principal payments from maturing securities during the first half of 2024.
In the second half, the ECB aims to reduce the PEPP portfolio by an average of $8.15 billion per month. Hence, it intends to stop reinvestments under the PEPP at the end of 2024. To address risks related to the pandemic’s impact on monetary policy, the Governing Council will maintain flexibility in reinvesting redemptions in the PEPP portfolio. This strategy is designed to safeguard the effectiveness of the monetary policy transmission mechanism.
The ECB’s decisions regarding the decline in the APP portfolio and the PEPP reinvestment plan are part of its broader monetary policy. These measures can influence market conditions and contribute to the ECB’s overall efforts to achieve its policy objectives, including managing interest rates for economic stability.
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Refinancing operations
As banks repay amounts they borrowed under targeted longer-term refinancing operations, the Governing Council will regularly assess the impact of these repayments on its monetary policy stance. This assessment includes the contribution of ongoing targeted lending operations to the overall stance of monetary policy.
Cautious approach
ECB’s decision reflects a cautious approach, balancing inflationary concerns with the need for sustained monetary policy measures and interest rates to achieve its medium-term target. The central bank remains vigilant in its commitment to flexibility, closely monitoring economic and financial developments in the pursuit of price stability.
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