 You're listening to the ECB podcast, bringing you insights into the world of economics and central banking. My name is Stefania Secola. Today is Thursday, the 14th of December 2023. And it's time for our regular episode on the monetary policy decisions by our governing council. I'll be back at the end of the episode. Now you'll hear President Christine Lagarde explain those decisions in our press conference. The governing council today decided to keep the three key ECB interest rates unchanged. While inflation has dropped in recent months, it is likely to pick up again temporarily in the near term. According to the latest Euro system staff projections for the Euro area, inflation is expected to decline gradually over the course of next year before approaching our 2% target in 2025. Overall, staff expects headline inflation to average 5.4% in 2023, 2.7% in 2024, 2.1% in 2025, and 1.9% in 2026. Compared with the September staff projections, this amounts to a downward revision for 2023 and especially for 2024. Underlying inflation has eased further, but domestic price pressures remain elevated, primarily owing to strong growth in unit labor costs. Euro system staff expect inflation excluding energy and food to average 5% in 2023, 2.7% in 2024, 2.3% in 2025, and 2.1% in 2026. Our past interest rate increases continue to be transmitted forcefully to the economy. Tighter financing conditions are dampening demand, and this is helping to push down inflation. Euro system staff expect economic growth to remain subdued in the near term. Beyond that, the economy is expected to recover because of rising real income, as people benefit from falling inflation and growing wages, and improving foreign demand. Euro system staff therefore see growth picking up from an average of 0.6% for 2023 to 0.8% for 2024 and to 1.5% for both 2025 and 2026. We are determined to ensure that inflation returns to our 2% medium-term target in a timely manner. Based on our current assessment, we consider that the key ECB interest rates are at levels that maintained for a sufficiently long duration will make a substantial contribution to this goal. Our future decisions will ensure that our policy rates will be set at sufficiently restrictive levels for as long as necessary. We will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, our interest rate decisions will be based on our assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. The key ECB interest rates are our primary tool for setting the monetary policy stance. We also decided today to advance the normalization of the Euro systems balance sheet. The governing council intends to continue to reinvest in full the principal payments from maturing securities purchased under the Pandemic Emergency Purchase Programme during the first half of 2024. Over the second half of the year, it intends to reduce the PEP portfolio by 7.5 billion euros per month on average. The governing council intends to discontinue reinvestment under the PEP at the end of 2024. The decisions taken today are set out in a press release available on our website. I will now outline in more details how we see the economy and inflation developing, and will then explain our assessment of financial and monetary conditions. Turning to the economic activity. The euro area economy contracted slightly in the third quarter, mostly owing to a decline in inventories. Tighter financing conditions and subdued foreign demand are likely to continue weighing on economic activity in the near term. Prospects are especially weak for construction and manufacturing, the two sectors most affected by higher interest rates. Services activity is also set to soften in the coming months. This is due to spillovers from weaker industrial activity, fading effects from the reopening of the economy, and the broadening impact of tighter financing conditions. The labour market continues to support the economy. The unemployment rate stood at 6.5% in October, and employment grew by 0.2% over the third quarter. At the same time, the weaker economy is dampening the demand for workers, with firms advertising fewer vacancies in recent months. Moreover, even though more people are in work, the total number of hours worked edged down by 0.1% in the third quarter. As the energy crisis fades, governments should continue to roll back the related support measures. This is essential to avoid driving up medium term inflationary pressures, which would otherwise call for even tighter monetary policy. Fiscal policies should be designed to make our economy more productive and to gradually bring down high public debt. Structural reforms and investments to enhance the euro area's supply capacity, which would be supported by the full implementation of the next generation EU programme, can help reduce price pressures in the medium term while supporting the green and digital transitions. To that end, it is important to swiftly agree on the reform of the EU's economic governance framework. Moreover, it is imperative that progress towards capital markets union and the completion of the banking union be accelerated. So let's look at inflation. Inflation dropped over the past two months, falling to an annual rate of 2.4% in November, according to Eurostat flash release. This decline was broad based. Energy price inflation fell further, and food price inflation also came down, despite remaining relatively high overall. This month, December, inflation is likely to pick up on account of an upward base effect for the cost of energy. In 2024, we expect inflation to decline more slowly because of further upward base effects and the phasing out of past fiscal measures aimed at limiting the repercussions of the energy price shock. Inflation excluding energy and food dropped by almost a full percentage point over the past two months, falling to 3.6% in November. This reflects improving supply conditions, the fading effects of the past energy shock, and the impact of tighter monetary policy on demand and on the pricing power of firms. The inflation rates for goods and services fell respectively to 2.9% and 4%. All measures of underlying inflation declined in October, but domestic price pressures remained elevated, chiefly because of strong wage growth, together with falling productivity. Measures of longer-term inflation expectations mostly stand around 2%, with some market-based indicators of inflation compensation declining from elevated levels. So what's our risk assessment? The risks to economic growth remain tilted to the downside. Growth could be lower if the effects of monetary policy turn out stronger than expected. A weaker world economy or a further slowdown in global trade would also weigh on euro area growth. Russia's unjustified war against Ukraine and the tragic conflict in the Middle East are key sources of geopolitical risk. This may result in firms and households becoming less confident about the future. Growth could be higher if rising real incomes raise spending by more than anticipated, or the world economy grows more strongly than expected. Upside risks to inflation include the heightened geopolitical tensions, which could raise energy prices in the near term, and extreme weather events, which could drive up food prices. Inflation could also turn out higher than anticipated if inflation expectations were to move above our target, or if wages or profit margins increased by more than expected. By contrast, inflation may surprise on the downside if monetary policy dampens demand by more than expected of the economic environment in the rest of the world, worsens unexpectedly, potentially owing in part to the recent rise in geopolitical risks. So let's now turn to the financial and monetary conditions. Market interest rates have fallen markedly since our last meeting and lie below the rates embedded in the staff projections. Our restrictive monetary policy continues to transmit strongly into broader financing conditions. Lending rates rose again in October to 5.3% for business loans and 3.9% for mortgages. Higher borrowing rates, subdued loan demand and tighter loan supply have further weakened credit dynamics. Loan to firms declined at an annual rate of 0.3% in October and loans to households also remained subdued, growing at an annual rate of 0.6%. With weaker lending and the reduction in the Euro system balance sheet, broad money, as measured by M3, has continued to contract. In October, it fell at an annual rate of 1%. In line with our monetary policy strategy, the governing council thoroughly assessed the links between monetary policy and financial stability. Euro area banks have demonstrated their resilience. They have high capital ratios and have become significantly more profitable over the past year. But the financial stability outlook remains fragile in the current environment of tightening financing conditions, weak growth and geopolitical tensions. In particular, the situation could worsen if banks' funding costs were to increase by more than expected and if more borrowers were to struggle to repay their loans. At the same time, the overall impact of such a scenario on the economy should be contained if financial markets react in an orderly fashion. Macro-prudential policy remains the first line of defence against the build-up of financial vulnerabilities and the measures in place contribute to preserving the financial system's resilience. So, in conclusion, the governing council today decided to keep the three key ECB interest rates unchanged. We are determined to ensure that inflation returns to our 2% medium-term target in a timely manner. Based on our current assessment, we consider that rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to our target. Our future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary to ensure such a timely return. We will continue to follow a data-dependent approach to determining the appropriate level and duration of restrictions. The governing council intends to reduce the PEP portfolio over the second half of 2024 and to discontinue its reinvestment under the PEP at the end of 2024. In any case, we stand ready to adjust all of our instruments within our mandate to ensure that inflation returns to our medium-term target and to preserve the smooth functioning of monetary policy transmission. That was President Christine Lagarde presenting the monetary policy decisions in today's press conference. If you want to know more, please check out the show notes. There you will find visual material about our governing council decisions, the full transcript of the discussion with journalists during the press conference and our projections on how we see inflation and the economy evolving. The next press conference will be on 25 January 2024. In the meantime, stay tuned for new episodes. You'll be listening to the ECB podcast with Stefania Secola. If you like what you've heard, please subscribe and leave us a review. In the spirit of Europe, I'd like to end in German today and say bis bald. Until next time, thanks for listening.