2.2 The European Central Bank's monetary policy and its preparation in 2020
The main task of the Eurosystem's monetary policy is to keep prices stable in the euro area. Price stability is defined as maintaining an inflation rate of below, but close to 2%, over the medium term. Here, the value of money is held more or less unchanged and strong purchasing power is preserved.
Price stability is the foundation for sustainable economic growth. The Eurosystem has traditionally maintained price stability by adjusting its key interest rates, which determine the costs banks face when borrowing money from or making deposits with the central bank.
In recent times, the Eurosystem has complemented its interest rate policy with non-standard measures of monetary policy to achieve its inflation target and maintain favourable financing conditions in the euro area. These non-standard measures include the Eurosystem's asset purchase programmes.
The Eurosystem comprises the European Central Bank (ECB) and the national central banks of the euro area. As a member of the Eurosystem, the Bank of Finland participates in the preparation, decision-making and implementation of the euro area's single monetary policy. The Governor of the Bank of Finland, Olli Rehn sits on the Eurosystem's highest decision-making body, the Governing Council of the ECB.
The Governing Council further eased its monetary policy in 2020 due to the pandemic
In 2020, euro area output growth contracted and inflation expectations and actual inflation declined sharply due to the COVID-19 pandemic. The Governing Council acted on the weak outlook by easing its monetary policy multiple times, using several tools to implement its policy stance.
The accommodative stance of monetary policy helps preserve favourable financing conditions for all sectors of the euro area economy.
The Governing Council relaxed its already accommodative monetary policy stance over the course of 2020. The Governing Council held the ECB deposit facility rate at -0.5% and similarly held the other ECB key interest rates unchanged. The conditions on the ECB's targeted longer-term refinancing operations (TLTROs) were further eased, and a new series of non-targeted pandemic emergency longer-term refinancing operations was launched.
The Eurosystem continued its net purchases under the asset purchase programme (APP) at a monthly pace of EUR 20 billion. The Governing Council also announced a temporary envelope of EUR 120 billion for additional net asset purchases on top of the existing programmes. Finally, the Governing Council launched a new pandemic emergency purchase programme (PEPP), with a maximum envelope eventually revised up to EUR 1,850 billion.
In its forward guidance, the Governing Council stressed the need for a sustained period of monetary accommodation to preserve favourable financing conditions and support output growth. Here, core inflation, which excludes energy and food prices, will be allowed to strengthen and support the convergence of headline inflation towards the inflation target over the medium term.
The European Central Bank and the European System of Central Banks (ESCB) continued to work on their monetary policy strategy review all the way through 2020.
The goal of the strategy review is to ensure that the ECB is adequately equipped to achieve its mandate and, by extension, is best positioned to serve the interests of the citizens of the euro area. The strategy review is due to be completed in mid-2021.
Monetary policy will remain highly accommodative in the coming years
In 2020, the ECB’s monetary policy stance remained highly accommodative. The accommodative monetary policy contributes to maintaining very favourable bank lending conditions and supports access to financing across all economic sectors.
The aim of the ECB's monetary policy is to support the robust convergence of inflation to levels below, but close to 2% over the medium term.
At the end of 2020, real output growth in the euro area remained muted and inflation low. Nevertheless, the Eurosystem staff projections published in December forecast inflation as picking up and moving closer towards target in the coming years.
The Governing Council stressed that an ample degree of monetary accommodation will remain necessary for an extended period of time.
The European Central Bank's monetary policy and its preparation in 2020
The main objective of the European Central Bank's monetary policy is to maintain price stability in the euro area. The Governing Council has interpreted this as keeping the annual growth of consumer prices below, but close to 2% over the medium term.
Monetary policy can also support the other economic policy objectives of the EU, as long as the objective of price stability is not jeopardised.
The Act on the Bank of Finland stipulates that the primary mission of the Bank of Finland is to maintain price stability as defined in the Treaty on European Union. The Bank of Finland and the Eurosystem also have other objectives, but price stability is always the primary objective.
The Governor of the Bank of Finland is a member of the ECB Governing Council and, as such, participates in the formulation of monetary policy.
Experts from the Bank of Finland contribute widely to the preparation of monetary policy decisions and other background work. They participate in economic analyses and monetary policy decisions and are active members on the Eurosystem's Monetary Policy Committee and Market Operations Committee.
Monetary policy decisively eased in response to COVID-19 pandemic and the deteriorating outlook
Persistent uncertainties related to geopolitical factors and protectionism marred economic sentiment in early 2020.
Significant sources of uncertainty included the United States’ continued trade dispute with China and, for Europe in particular, the United Kingdom's withdrawal from the European Union and the protracted divorce process.
These factors have long been a drag on output growth in the euro area and have also contributed to keeping inflation expectations muted.
A novel COVID-19 (COVID-19) outbreak in the Chinese city of Wuhan escalated into a pandemic during the first quarter of 2020.
Uncertainty over the effects of the virus, including its infectiousness and deadliness, swiftly led to lockdowns being imposed in the euro area and elsewhere in the world.
The lockdown measures and mounting uncertainty quickly eroded the outlook for economic activity in all of the major economies.
The ECB Governing Council responded to the deteriorating outlook by easing its monetary policy stance multiple times during 2020.
The Governing Council stressed that monetary policy will have to remain highly accommodative for a prolonged period to support underlying inflation pressures and headline inflation developments over the medium term.
The Governing Council continues to closely monitor inflation developments and the impact of unfolding monetary policy measures on the economy. The accommodative stance of monetary policy will help to safeguard highly favourable financing conditions across the euro area.
The Governing Council stressed at each of its monetary policy meetings in 2020, as well as in connection with other communication events, that it would continue to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner.
Monetary policy remained highly accommodative in early 2020
At its first monetary policy meeting of 2020, on 23 January, the Governing Council noted that euro area growth had continued at a moderate pace.
The Governing Council assessed that ongoing, albeit decelerating, employment growth and increasing wages would continue to support the resilience of the euro area economy.
While inflation developments remained subdued overall, there were some signs of a moderate increase in underlying inflation.
In light of its economic and monetary analyses, the Governing Council decided not to change its monetary policy stance. It held the key ECB interest rates unchanged, with the deposit facility rate held at -0.5%, the main refinancing operations rate at 0.0%, and the marginal lending facility rate at 0.25%.
The Governing Council stated that it expected the key ECB interest rates to remain at their present or lower levels until it had seen the inflation outlook robustly converge to a level sufficiently close to, but below 2% within its projection horizon, and such convergence had been consistently reflected in underlying inflation dynamics.
Net purchases under the Eurosystem's asset purchase programme (APP), a non-standard measure of monetary policy, would continue at a monthly pace of EUR 20 billion. The Governing Council continued to expect monthly net asset purchases under the APP to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it started raising the key ECB interest rates.
The Governing Council also intended to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP. It would continue to do so for an extended period of time past the date when it started raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.
Finally, the Governing Council marked its first meeting of 2020 by formally launching a review of the ECB’s monetary policy framework.
Outlook dashed by COVID-19 pandemic in spring — Governing Council substantially eases monetary policy stance
Over the course of the spring the new and startling pandemic spread irrevocably across Europe. It became clear that the effects of the pandemic would take a heavy toll on the euro area economy, even if the pandemic itself remained short-lived.
The economic outlook deteriorated quickly, and financial markets experienced significant bouts of volatility. The pandemic was seen to be disrupting important supply chains, weakening economic output.
The measures put in place to mitigate the spread of the virus, such as restrictions on movement, weakened domestic and foreign demand. Moreover, the rise in general uncertainty was seen to be impeding economic planning and financing.
The March 2020 ECB staff macroeconomic projections foresaw euro area real gross domestic product (real GDP) as increasing by 0.8% in 2020, 1.3% in 2021 and 1.4% in 2022.
Compared with the December 2019 Eurosystem staff projections, the outlook for real output growth had been substantially revised down for 2020, and slightly for 2021.
Harmonised Index of Consumer Prices (HICP) inflation was projected at 1.1% in 2020, 1.4% in 2021 and 1.6% in 2022 by the ECB staff projections. Compared with the December 2019 projections, the outlook for HICP inflation remained unchanged.
At its meeting on 23 March, the Governing Council decided to further ease its monetary policy to support households, businesses and banks through the environment of uncertainty and through the economic shock caused by the pandemic.
First, the Governing Council decided to conduct, temporarily, additional longer-term refinancing operations (LTROs) to provide immediate liquidity support to the euro area financial system.
The LTROs provided liquidity at favourable terms to bridge the period until the TLTRO III operation in June 2020.
Second, the Governing Council decided to apply considerably more favourable terms during the period June 2020 to June 2021 to all TLTRO III operations outstanding during that time.
These operations would support bank lending to those affected most by the pandemic, in particular small and medium-sized enterprises. In addition, the Governing Council mandated the Eurosystem committees to investigate collateral easing measures to ensure that counterparties would continue to be able to make full use of its funding support.
Third, the Governing Council decided to add a temporary envelope of additional net asset purchases of EUR 120 billion until the end of the year, ensuring a strong contribution from the private sector purchase programmes. The Governing Council continued to expect net asset purchases to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it started raising the key ECB interest rates.
Lastly, the Governing Council decided to keep the key ECB interest rates unchanged, expecting them to remain at their present or lower levels until it had seen the inflation outlook robustly converge to a level sufficiently close to, but below 2% within its projection horizon, and such convergence had been consistently reflected in underlying inflation dynamics.
By the time of the Governing Council’s monetary policy meeting on 30 April, it was clear that the economic contraction was poised to be significantly sharper than previously estimated.
The lockdown measures put in place to thwart the virus had sapped aggregate demand in the euro area and elsewhere in the world. Indicators of consumer and business confidence plummeted, reflecting the massive deterioration of the economy and labour markets.
The soaring rise in uncertainty was also reflected in growth scenarios estimated by the ECB staff, which suggested that euro area real GDP could fall by between 5% and 12% in 2020. Headline inflation was projected to decline on the back of crude oil.
The assumptions underpinning the growth scenarios were subject to a high degree of uncertainty, seeing as it was difficult on one hand to estimate the extent of the shock, and on the other hand to estimate the success of monetary and fiscal policy in mitigating the adverse impact on incomes and employment.
At its April meeting, the Governing Council announced that it had decided to keep the key ECB interest rates unchanged but would extend its quantitative easing measures. It announced that it had decided to further ease the conditions on its targeted longer-term refinancing operations.
It also decided on a new series of non-targeted pandemic emergency longer-term refinancing operations (PELTROs) to support liquidity conditions in the euro area financial system and contribute to preserving the smooth functioning of money markets by providing an effective liquidity backstop.
The Governing Council noted that together with the substantial monetary policy stimulus already in place, these measures would support liquidity and funding conditions and help preserve the smooth provision of credit to the real economy.
The Governing Council added that the Eurosystem had since the end of March been conducting purchases under the new pandemic emergency purchase programme (PEPP), which at the time had an overall envelope of EUR 750 billion. The purchase programme had contributed to easing the overall monetary policy stance and strengthened the transmission of monetary policy in the euro area.
Its purchases are conducted in a flexible manner over time, across asset classes and among jurisdictions. The Governing Council announced that it would conduct net asset purchases under the PEPP until it judged that the COVID-19 crisis phase was over, but in any case at least until the end of 2020.
The pandemic waned over the summer, priming expectations of a return to growth in the second half of 2020
The euro area economy appeared to experience an unprecedented contraction during the second quarter of 2020. The enormous uncertainty caused by the pandemic cast a shadow over the future, and consumption and investment contracted in the euro area.
One silver lining was that a number of surveys and forward-looking indicators suggested that the contraction was beginning to stabilise as restrictions were gradually lifted.
Economic growth was expected to pick up in the second half of the year, backed especially by fiscal and monetary stimulus.
The outlook for inflation was seen as having broadly declined. On the one hand, this was in part due to the fall in energy prices caused by the pandemic. On the other hand, the significant contraction in output suggested a marked increase in economic slack, which was likely to keep cost pressures in check.
In the baseline scenario of the June 2020 Eurosystem staff macroeconomic projections, real GDP was expected to fall by 8.7% in 2020 but projected to grow by 5.2% in 2021 and by 3.3% in 2022.
Compared with the March 2020 ECB staff macroeconomic projections, the outlook for real GDP growth had been revised downwards by 9.5 percentage points for 2020 but revised upwards by 3.9 percentage points for 2021 and 1.9 percentage points for 2022.
Annual HICP inflation was projected at 0.3% in 2020, 0.8% in 2021 and 1.3% in 2022. Compared with the March projections, the outlook for HICP inflation had been revised downwards by 0.8 percentage points for 2020, 0.6 percentage points for 2021 and 0.3 percentage points for 2022.
In light of these data, the Governing Council decided to hold the key ECB interest rates unchanged at its meeting on 4 June, but increased the envelope for the pandemic emergency purchase programme (PEPP) by EUR 600 billion, to a new total of EUR 1,350 billion. The Governing Council also decided to extend the horizon for net purchases under the PEPP to at least the end of June 2021.
The Governing Council estimated that the PEPP expansion would further ease the general monetary policy stance and support funding conditions in the real economy, especially for businesses and households. The overall outlook for inflation in the immediate years ahead was revised downwards as a result of the pandemic.
Finally, the Governing Council decided it would continue to reinvest the maturing principal payments from securities purchased under the PEPP until at least the end of 2022. The future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance.
At its meeting on 16 July, the Governing Council confirmed that euro area real GDP had decreased in the first quarter of 2020 by 3.6%, quarter on quarter, and that GDP was expected to contract even further in the second quarter.
It expected euro area activity to rebound in the third quarter as containment measures were gradually lifted, supported by favourable financing conditions, an expansionary fiscal stance and a resumption in global activity.
The Governing Council decided to hold its very accommodative monetary policy stance unchanged.
Monetary policy stance held unchanged in the autumn
At its meeting on 10 September, the Governing Council confirmed that incoming data suggested a strong rebound in activity broadly in line with previous expectations, although the level of activity remained well below the levels prevailing before the COVID-19 pandemic.
The strength of the recovery remained shrouded in significant uncertainty, as it continued to be highly dependent on the future evolution of the pandemic and the impact of containment policies on different sectors of the economy.
Headline inflation was seen as being dampened by low energy prices and weak price pressures in the context of subdued demand and significant labour market slack.
This assessment was broadly reflected in the September 2020 ECB staff macroeconomic projections for the euro area. The projections anticipated annual real GDP growth of ‑8.0% in 2020, 5.0% in 2021 and 3.2% in 2022.
Compared with the June 2020 Eurosystem staff macroeconomic projections, the outlook for real GDP growth was revised up for 2020 and was largely unchanged for 2021 and 2022.
Annual HICP inflation was projected at 0.3% in 2020, 1.0% in 2021 and 1.3% in 2022. Compared with the June 2020 Eurosystem staff macroeconomic projections, the outlook for inflation remained unchanged for 2020, but was revised up for 2021. The outlook for inflation in 2022 remained unchanged from the June projections.
The Governing Council agreed that ample monetary stimulus remained necessary to support the economic recovery and to safeguard medium-term price stability. Therefore, the Governing Council decided to reconfirm its accommodative monetary policy stance.
In October there were signs of a resurgence of COVID-19 infections in Europe.
As the second wave of the pandemic gathered pace, governments imposed a new series of lockdown measures to contain the virus. The recovery of euro area activity that began during the summer started to fade more quickly than anticipated.
Mounting uncertainty weighed on economic activity. Headline inflation was being dampened by low energy prices and muted underlying price pressures in the context of weak demand and significant slack on labour and product markets.
At its monetary policy meeting of 29 October, the Governing Council decided that it would for the meantime reconfirm its accommodative monetary policy stance. The Governing Council noted that the risks surrounding the euro area growth outlook were clearly tilted on the downside.
As the second wave of the pandemic caused growth to slow, monetary policy was further relaxed towards the end of the year
In December, earlier estimates of the rebound in euro area activity during the third quarter were revised upwards; however, general uncertainty only intensified as the second wave of the pandemic spread farther and wider.
The Governing Council noted that the resurgence in COVID-19 cases and the associated containment measures were significantly restricting euro area economic activity, which was expected to have contracted in the fourth quarter of 2020.
The December 2020 Eurosystem staff macroeconomic projections for the euro area forecast annual real GDP growth at -7.3% in 2020, 3.9% in 2021, 4.2% in 2022 and 2.1% in 2023.
Compared with the September 2020 ECB staff projections, the outlook for economic activity was revised down in the short term, but was seen to broadly recover to the level projected in the September baseline scenario over the medium term.
Annual HICP inflation was forecast at 0.2% in 2020, 1.0% in 2021, 1.1% in 2022 and 1.4% in 2023. Compared with the September 2020 ECB staff projections, the outlook for inflation was revised down for 2020 and 2022.
At its monetary policy meeting of 10 December, the Governing Council decided to increase the envelope of the pandemic emergency purchase programme (PEPP) by EUR 500 billion, to a total of EUR 1,850 billion. It also extended the horizon for net purchases under the PEPP to at least the end of March 2022. The Governing Council added that, in any case, it would conduct net purchases until it judged that the COVID-19 crisis phase was over.
The extension of the PEPP reflected the Governing Council's assessment of a prolonged fallout from the pandemic for the economy and inflation.
Purchases under the PEPP are conducted to preserve favourable financing conditions in the euro area. If favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full. The PEPP is also a measure that eases the overall stance of monetary policy.
The flexibility of PEPP purchases over time, across asset classes and among jurisdictions contributes to the smooth transmission of monetary policy. This has reduced the risks on different markets and created a stabilising market mechanism, thus also mitigating a tightening of financing conditions.
The Governing Council also decided to extend the reinvestment of principal payments from maturing securities purchased under the PEPP until at least the end of 2023. The future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance.
The Governing Council also decided to further recalibrate the conditions of the third series of targeted longer-term refinancing operations (TLTRO III). Specifically, it decided to extend by twelve months the period over which considerably more favourable terms were applied, to June 2022.
The TLTRO III operations preserve very attractive funding conditions for banks. This will help to ensure that they can continue to offer favourable lending conditions and have ample liquidity to extend loans to households and firms.
Growth requires support from other policy areas, not monetary accommodation alone
In sum, the ECB's monetary policy stance has been highly accommodative. The purpose of a light monetary policy is to ensure that financing conditions remain favourable for all sectors of the economy.
An accommodative monetary policy contributes to maintaining very favourable bank lending conditions and supports access to financing across all economic sectors.
In particular, easier borrowing conditions for firms and households help support consumer spending and business investment. This will sustain the euro area expansion, the build-up of domestic price pressures and, thus, the robust convergence of inflation towards the medium-term aim.
Raising the economy's growth potential and supporting aggregate demand will also require contributions from policy areas other than monetary policy.
The ECB Governing Council has consistently and publicly called for more decisive action towards implementing the structural policies outlined in the European Commission's country-specific recommendations.
An ambitious and coordinated fiscal stance remains critical, in view of the sharp contraction in the euro area economy.
Fiscal measures taken in response to the pandemic emergency should, as much as possible, be targeted and temporary in nature.
The Governing Council stresses that the transparent and consistent implementation of the European Union’s fiscal and economic governance framework over time and across countries remains essential to bolster the resilience of the euro area economy. Improving the functioning of Economic and Monetary Union remains a priority.
The Governing Council welcomes the ongoing work and urges further specific and decisive steps to complete the Banking Union and the Capital Markets Union.