Quarterly Planning Retreat 2023: Mapping Strategies and Goals for the Year Ahead
Introduction
This article accounts for the monetary policy meeting held by the Governing Council of the European Central Bank on February 1-2, 2023. The main focus of the meeting was the review of financial, economic, and monetary developments and policy options.
II. Financial Market Developments
The Governing Council noted that its previous monetary policy meeting had left a visible footprint in euro area financial markets. Real interest rates had increased to levels that were more consistent with a timely return of inflation to the 2% target. However, a sharp decline in expected inflation due to lower gas prices and inflation surprises to the downside had contributed to market participants revising their rate expectations.
Expectations of rapid disinflation have induced markets to price in material rate cuts as of 2024. This had boosted risk sentiment, and risk premia had declined measurably across market segments. However, the compression in risk premia was predicated on the markets’ firm conviction that inflation dynamics were on a steep and sustained downward trajectory towards 2%. A stronger persistence of underlying price pressures could lead to a reappraisal of the monetary policy outlook and a correction in asset prices.
III. Review of Economic Developments
The Governing Council noted further signs of a more resilient euro area economy and the reopening of China’s economy. However, the model-based analysis suggested that the decline in the market-based inflation outlook had two broad origins. First, there have been some misses to the downside relative to expectations for euro area headline inflation since November. Second, there had been a sharp decline in expected inflation, mainly over the near term.
IV. Policy Options
Given the downside risks to the economy and the uncertainty over the inflation outlook, the Governing Council agreed that it was necessary to maintain a highly accommodative monetary policy stance. Therefore, it instructed the Eurosystem to continue its purchases under the pandemic emergency purchase program (PEPP) with a total envelope of € 1.85 trillion and to do so at a significantly higher pace over the next few months than in the first quarter of 2023. The Governing Council also stood ready to adjust all of its instruments, as appropriate, to ensure that inflation stabilizes at the target over the medium term.
V. Related Facts
– Market participants revised their expectations of rate cuts as of 2024, thanks to rapid disinflation.
– The compression in risk premia was predicated on the markets’ conviction that inflation dynamics were downward toward 2%.
– The Governing Council agreed that it was necessary to maintain a highly accommodative monetary policy stance.
VI. Key Takeaway
The Governing Council of the European Central Bank agreed to maintain its highly accommodative monetary policy stance and requested the Eurosystem to continue its purchases under the PEPP at a significantly higher pace over the next few months. The strong persistence of underlying price pressures could lead to a correction in asset prices.
VII. Conclusion
The ECB’s Governing Council noted that its previous monetary policy meeting had left a visible footprint in euro area financial markets. Given the downside risks to the economy and the uncertainty over the inflation outlook, it was necessary to maintain a highly accommodative monetary policy stance. The Governing Council stood ready to adjust all of its instruments, as appropriate, to ensure that inflation stabilizes at the target over the medium term.
