In the Economic Bulletin on inflation: “Risks of increased inflation from geopolitical tensions and calamities, determined by a timely return of 2% in the medium term”
“Future decisions by the Governing Council will ensure that policy rates are set at sufficiently restrictive levels for as long as necessary.” Thus the ECB in the Economic Bulletin added that it is determined “to ensure the timely return of inflation to the objective of 2 percent in the medium term” and is ready “to adapt all the tools at its disposal within its mandate to ensure that returns to its medium-term objective and to preserve the orderly transmission of monetary policy”.
. “Based on the current assessment, the Governing Council considers that the key ECB interest rates are at levels that, if maintained for a sufficiently long period, will make a substantial contribution to achieving this objective,” it notes.
“The Governing Council – it is underlined in the document – will continue to follow a data-driven approach in determining the appropriate level and duration of the restrictive stance. In particular, decisions on interest rates will be based on the assessment of the inflation outlook in light of the data most recent economic and financial developments, the dynamics of underlying inflation and the intensity of monetary policy transmission”. The ECB’s reference interest rates “represent the main tool for defining the monetary policy orientation”, it adds.
Inflation, although it has decreased in recent months, will probably return to record a temporary increase in the short term and then continue its gradual decline, it is noted. According to the macroeconomic projections for the euro area formulated in December 2023 by Eurosystem experts, inflation would gradually reduce during 2024, before approaching the 2 percent objective pursued by the Governing Council in 2025. Overall, Eurosystem experts expect headline inflation to stand, on average, at 5.4 percent in 2023, 2.7 in 2024, 2.1 in 2025 and 1.9 in 2026. Compared to last September, the projections for the euro area have been revised downwards for 2023 and especially for 2024.
L’underlying inflation recorded a further decline. According to the ECB, domestic price pressures, however, remain high, mainly due to the strong growth in unit labor costs. Eurosystem experts expect inflation net of energy and food components to be equal, on average, to 5 percent in 2023, 2.7 in 2024, 2.3 in 2025 and 2.1 in 2026.
However, geopolitical tensions and disasters could lead to a rise in inflation. This is what emerges from the ECB’s Economic Bulletin.”Upside risks to inflation include increased geopolitical tensions, which could lead to an increase in energy prices in the short term, and extreme weather events, which could push up food prices”, we read. “Furthermore, inflation could be higher than expected if expectations rise above the Governing Council’s target or if wages or profit margins increase more than expected,” it added.
On the contrary, inflation could surprise on the downside if monetary policy curbs demand to a greater extent than expected or in the event of an unexpected deterioration of the economic environment in the rest of the world, due to the possible effect, among other things, of recent increase in geopolitical risks.
“As the energy crisis abates, governments should continue to withdraw their support measures. This is essential to avoid pushing up medium-term inflationary pressures, which would otherwise require an even more restrictive monetary policy”, it was then the ECB’s warning to governments.
“Fiscal policies should be formulated with the aim of increasing the productivity of the euro area economy and gradually reducing the high public debt”, the ECB further points out, adding: “Structural reforms and investments aimed to improve the area’s supply capacity, which would benefit from the full implementation of the Next Generation Eu programme, can help reduce price pressures in the medium term, while supporting the ecological and digital transitions. To this end, it is important to achieve an agreement on the reform of the EU economic governance framework quickly. It is also essential to accelerate progress towards the realization of the capital markets union and the completion of the banking union”, it adds.
The ECB also signals risks to eurozone growth due to a higher-than-expected effect of monetary tightening and the impact of the war in Ukraine and the crisis in the Middle East.
“Risks for economic growth remain oriented to the downside. Economic expansion could be lower if the effects of monetary policy prove stronger than expected. A weakening of the world economy or a further slowdown in international trade would also weigh on growth “the euro area. Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East are significant sources of geopolitical risk,” it said.
This could lead, it is added, “in businesses and families, to a loss of confidence regarding the future. The economic expansion could prove to be higher if, thanks to the increase in real incomes, spending increased more than expected, or if the world economy grew more than expected.”