President Lagarde has indicated three key criteria for judging whether the stance of monetary policy is appropriate: the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission.
The inflation scenario has improved significantly in recent weeks. Eurozone consumer price (CPI) inflation fell to 6.1% year-on-year in May and core inflation also eased. While current inflation remains elevated relative to the ECB’s 2% target, lower commodity prices – including energy, industrial metals, agricultural goods and fertilizers – suggest that inflation will fall further. These falls have led to a collapse in producer price (PPI) inflation.
Also supporting the prospect of lower CPI inflation, corporate surveys show there is a lower tendency to increase prices compared to the end of 2022, although it remains relatively high among services firms. And consumers’ inflation expectations have dropped in recent months. Finally, it is noteworthy that the slowdown in GDP will also encourage inflation to return towards 2%.
Underlying inflation has improved a little but remains too high, especially in the services sector. The annualised quarterly change in the prices of services remains just below 6% and does not show clear signs of moderation. Although services prices increased by only 0.12% month-on-month in May, further clear signs of moderation are necessary before the ECB can conclude that services price inflation is returning towards 2%.
Conversely, the dynamics of energy, food and industrial goods prices have moderated in recent months and are likely to continue to do so, given lower commodity prices and the trend in US durable goods prices.
The third factor mentioned by President Lagarde was the transmission of monetary policy. She said on 1 June that “considerable tightening is still in the pipeline” even after the rapid and aggressive rate hikes totalling 3.75% implemented since July 2022. A reduction in the availability of credit is also evident, reflecting the tightening of conditions applied by commercial banks on lending to the private sector and the reaction by businesses and households to significantly reduce the demand for credit. Net credit flows have been virtually zero since September 2022 and the inflation-adjusted annual change in the stock of outstanding bank loans is already weaker than the low point reached during the eurozone debt crisis in 2011-13.
In an interview on 7 June, Executive Board member Isabel Schnabel, said that the impact of the ECB’s restrictive monetary policy “on inflation is expected to peak in 2024”. However, she noted that this process is uncertain and depends on private sector expectations. Furthermore, the cost of a policy that is not restrictive enough is higher than one that is too restrictive. Interestingly, the responses of corporates and households to EU Commission and ECB surveys are consistent with a relatively quick return of inflation towards the ECB’s 2% target.
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