Inflation Decreases, but Expected to Remain High for an Extended Period
In the 15th June 2023 meeting, the Governing Council decided to raise the European Central Bank’s (ECB) three official rates by 25 basis points in order to ensure that inflation returns to the 2 percent target in the medium term. This rate hike reflects the Governing Council’s updated assessment of inflation prospects, underlying inflation developments, and the strength of monetary policy transmission. According to the Eurosystem staff’s macroeconomic projections from June 2023, average annual inflation in the euro area is expected to be 5.4 percent in 2023, 3.0 percent in 2024, and 2.2 percent in 2025. The indicators of underlying price pressures remain strong, although there are some signs of softening. The staff has revised upward the projections for inflation excluding energy and food, especially for this year and next year, due to previous surprising increases and the robustness of the labor market’s impact on the disinflationary pace. It is now expected to reach 5.1 percent in 2023 before declining to 3.0 percent in 2024 and 2.3 percent in 2025. The staff has made a slight downward revision to the economic growth projections for this year and next year. The current expectations are for economic growth of 0.9 percent in 2023, 1.5 percent in 2024, and 1.6 percent in 2025.
The Impact of Previous Rate Increases and Tighter Financing Conditions
The previous rate hikes by the Governing Council are strongly influencing financing conditions and gradually affecting the entire economy. Loan costs have increased significantly, and loan growth is slowing down. Tighter financing conditions are one of the main reasons why inflation is expected to further decrease toward the target, as they are expected to increasingly dampen demand.
Future Monetary Policy Decisions
The Governing Council’s future decisions will ensure that ECB’s official rates are set at a sufficiently restrictive level to bring inflation back to the 2 percent target in the medium term. The Governing Council will keep rates at this level for as long as necessary. The Council will continue to use a data-driven approach when determining the level and duration of these restrictive measures. The interest rate decisions of the Governing Council are based on an assessment of inflation prospects, considering new economic and financial data, developments in underlying inflation, and the strength of monetary policy transmission.
End of Asset Purchase Program (APP) Reinvestments
The Governing Council confirmed its decision to bring reinvestments under the Asset Purchase Program (APP) to an end from July 2023.
Economic, Financial, and Monetary Development
Global Economic Activity
The global economy strengthened this year compared to the fourth quarter of 2022, thanks to the reopening of the Chinese economy and robust labor markets in the US. The global activity was mainly driven by the services sector, while manufacturing production remains relatively subdued. The aftermath of problems in the US banking sector in early March led to a brief period of acute stress in global financial markets. Most prices have since recovered from this period. However, market participants have also adjusted their expectations for the future tightening of the Federal Reserve’s monetary policy. Nevertheless, ongoing uncertainty poses obstacles to global growth, including high inflation, tightening global financial conditions, and geopolitical tensions. Against this backdrop, the global growth and inflation outlooks in the June 2023 projections are largely unchanged from the ECB staff’s macroeconomic projections in March 2023 for the euro area. The modest upward revision of global growth in 2023 is primarily due to the rebound in demand in China in the first quarter, which was stronger than expected but partially offset by the negative effect of tighter financial and credit conditions in the US and other advanced economies. The inflation outlook has been slightly revised upward for 2024, reflecting tight labor markets and continued high wage growth in advanced economies, while lower commodity prices explain a small downward revision in expected inflation for 2023. World trade is expected to grow much slower than real GDP this year, as the composition of global demand has become less trade-intensive. The outlook for world trade in 2023 has been revised downward, primarily due to significant negative spillovers from the fourth quarter of 2022 and weak performance in major economies in the first quarter.
Euro Area Economic Situation
The euro area economy has stagnated in recent months. Similar to the fourth quarter of last year, it contracted by 0.1 percent in the first quarter of 2023 due to a decline in private and public consumption. Economic growth is likely to remain weak in the short term but is expected to strengthen throughout the year as inflation falls and supply disruptions continue to diminish. The situation varies across different sectors of the economy, with the manufacturing sector continuing to weaken, partly due to lower global demand and tighter financing conditions in the euro area, while the services sector remains robust.
The labor market continues to be a strengthening factor. Nearly a million new jobs were created in the first quarter of the year, and unemployment remained at its historic low of 6.5 percent in April. The average number of hours worked has also increased but remains somewhat below pre-pandemic levels.
According to the June 2023 projections, the economy is expected to resume growth in the coming quarters as energy prices decrease, foreign demand strengthens, and supply bottlenecks are alleviated, allowing businesses to work through their significant order backlogs. Uncertainty, including recent stress in the banking sector, is expected to continue to diminish. There are also prospects for progress in real income supported by a robust labor market, where unemployment reaches a new historic low during the projection period. The tightening of monetary policy will increasingly impact the real economy. Along with the gradual withdrawal of fiscal support, this will weigh on economic growth in the medium term. Overall, the average annual growth in real GDP is expected to decrease to 0.9 percent in 2023 (from 3.5 percent in 2022) before rising again to 1.5 percent in 2024 and 1.6 percent in 2025. Compared to the March 2023 projections, the growth outlook has been revised downward by 0.1 percentage point for 2023 and 2024. This mainly reflects tighter financing conditions. The 2025 GDP growth remains unchanged as these effects are expected to be partially offset by the impact of higher disposable real income and reduced uncertainty.
Improved Fiscal Outlook and Policy Recommendations
The fiscal outlook for the euro area is expected to improve during the projection period. After a significant decline in 2022, the euro area’s budget deficit is expected to continue falling at a slower pace in 2023-24 and marginally in 2025 (to 2.5 percent of GDP). The decline in the budget balance toward the end of the projection period compared to 2022 can be explained by improvement in the cyclically adjusted primary balance and, to a lesser extent, by a better cyclical fiscal component, while interest payments as a share of GDP are expected to gradually increase during the projection period. The euro area’s debt is expected to continue decreasing, albeit at a slower pace after 2022, reaching 87.3 percent ofHeadline: Denmark’s Economy Faces High Inflation, ECB Raises Interest Rates
Date: June 15, 2023
In a recent report on the economic, financial, and monetary development in Denmark, it has been highlighted that inflation has fallen but is expected to remain high for an extended period. To address this concern, the Danish Central Bank’s Governing Council has decided to raise the European Central Bank’s (ECB) three official interest rates by 25 basis points.
The increase in interest rates reflects the Council’s updated assessment of inflation prospects, the underlying inflation development, and the strength of monetary policy transmission. According to the ECB’s macroeconomic projections for June 2023, the euro area is expected to experience an average annual inflation of 5.4% in 2023, 3.0% in 2024, and 2.2% in 2025. While there are signs of easing, indicators of underlying price pressure remain strong. The projections for inflation, excluding energy and food, have been revised upward, particularly for this year and next year, due to unexpected increases and the robust impact of the labor market on the pace of disinflation. It is now expected to reach 5.1% in 2023 before declining to 3.0% in 2024 and 2.3% in 2025. On the other hand, the projections for economic growth in the country have been slightly downgraded. The forecast now expects economic growth of 0.9% in 2023, 1.5% in 2024, and 1.6% in 2025.
The previous interest rate hikes by the Danish Central Bank are beginning to impact financing conditions and gradually influence the overall economy. Loan costs have increased significantly, and loan growth is decelerating. Tighter financing conditions are one of the main reasons why inflation is expected to further decline towards the target, as they are increasingly expected to dampen demand.
The Governing Council’s future decisions will ensure that the ECB’s official interest rates are set at a sufficiently restrictive level to timely bring inflation back to the 2% target over the medium term. The Council will keep rates at this level for as long as necessary and will continue to use a data-driven approach when determining the level and duration of these restrictive measures. The Council also confirmed its plan to terminate reinvestments under the asset purchase program (APP) from July 2023.
Regarding the global economic situation, the report highlights that the global economy has strengthened this year, primarily due to the reopening of the Chinese economy and robust labor markets in the US. However, there are lingering uncertainties, including high inflation, tightening global financial conditions, and geopolitical tensions, which could hinder global growth, including in the euro area.
The report also discusses the economic activity within the euro area, stating that it has stagnated in recent months. The economic growth is expected to remain weak in the short term but is projected to strengthen as inflation falls and supply disruptions continue to diminish. The manufacturing sector continues to weaken, partly due to lower global demand and tighter financing conditions, while the services sector remains robust. The labor market continues to be a strengthening factor, with nearly a million new jobs created in the first quarter of the year, and unemployment remaining at a historic low of 6.5% in April. The projections anticipate economic growth in the coming quarters, supported by declining energy prices, strengthened foreign demand, and the easing of supply bottlenecks.
The report also discusses inflation trends in Denmark. In May, inflation decreased further to 6.1% from 7.0% in April. The decrease was broad-based, with energy inflation returning to negative territory and food inflation decreasing but remaining high at 12.5%. The inflation rate excluding energy and food also declined for the second consecutive month to 5.3% in May. While indicators of underlying price pressure remain strong, there are some signs of easing.
The report acknowledges that the outlook for economic growth and inflation remains highly uncertain. Downside risks to growth include geopolitical tensions, which could fragment global trade and weigh on the euro area’s economy, as well as potentially stronger-than-expected effects of monetary policy. Renewed financial market tensions could also tighten financing conditions further and weaken confidence. However, growth could be higher than expected if the strong labor market and reduced uncertainty boost both private and corporate confidence.
The Danish Central Bank’s decision to raise interest rates aims to address the persistently high inflation. The report emphasizes the bank’s commitment to maintaining interest rates at a level that is sufficiently restrictive to bring inflation back to the target of 2% over the medium term. The bank will continue to employ a data-driven approach in determining the level and duration of these restrictive measures.
Overall, the report highlights the challenges posed by high inflation and the need for vigilant monetary policy. It also emphasizes the importance of coordinated actions to mitigate inflationary pressures and maintain financial stability in Denmark.