2.2 European Central Bank’s monetary policy formulation and implementation in 2022

The European Central Bank (ECB) tightened its monetary policy rapidly in the latter half of 2022 by raising interest rates and reducing liquidity. The ECB will continue to tighten monetary policy in 2023 to ensure a sustained return of inflation to the target of 2% over the medium term.

The main objective of the Eurosystem’s monetary policy is to maintain price stability in the euro area. The price stability objective defined by the ECB’s Governing Council means a symmetric 2% inflation target over the medium term. This allows the value of money to remain more or less unchanged and purchasing power to remain strong.

The ECB’s monetary policy also supports other EU economic policy goals wherever possible, such as sustainable economic growth and employment, provided that this does not prejudice the price stability objective.

The Eurosystem comprises the European Central Bank 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, is a member of the Eurosystem’s highest decision-making body, the Governing Council of the ECB.

Key interest rates were raised and liquidity reduced

The ECB tightened its monetary policy throughout the course of 2022.

At the start of 2022 the key ECB interest rates were at -0.50% (deposit facility rate), 0.00% (main refinancing operations rate) and 0.25% (marginal lending facility rate).

By the end of 2022 the key rates had each been raised by altogether 2.5 percentage points and stood at 2.00%, 2.50% and 2.75%, respectively.

The Governing Council signalled that it would continue raising interest rates until it saw a sustained return of inflation to the target of 2% over the medium term.

In October 2022, the Governing Council decided to change the terms and conditions of the third series of targeted longer-term refinancing operations (TLTRO III). The interest rates on outstanding TLTROs III were adjusted, and banks were offered additional days for making early voluntary liquidity repayments.

The pandemic emergency purchase programme (PEPP) was ended in March 2022, and the asset purchase programme (APP) in July 2022.

In December 2022, the ECB’s Governing Council decided that from the beginning of March 2023, it will reduce its reinvestment of maturing securities purchased under the APP at an average monthly pace of EUR 15 billion until the end of June, and that the subsequent pace of reinvestments will be determined over time. As a result of the decision, the ECB balance sheet will begin to shrink.

Uncertain economic outlook at the start of 2022

In its February 2022 assessment, the Governing Council concluded that GDP growth would likely remain subdued in the first quarter and that inflation would continue to rise.

Growth was seen as picking up in the latter half of the year, and inflation was expected to remain elevated but to moderate towards the end of the year.

Based on this information, the Governing Council, at its February meeting, confirmed its earlier monetary policy decisions taken in December 2021, including the decision to discontinue net purchases under the PEPP by the end of March 2022.

Economic outlook deteriorated in the spring

At its monetary policy meeting in March 2022, the ECB’s Governing Council noted that the outlook for growth and inflation had been weakened by Russia’s invasion of Ukraine at the end of February.

It was considered that the full impact of the conflict would depend not only on the particular course it would take, but also on the effect of the sanctions and on other factors. Above all, it was considered that the conflict would bring additional economic uncertainty.

ECB staff projections for euro area GDP growth were revised downwards. The new projections put real GDP growth at 3.7% in 2022, 2.8% in 2023 and 1.6% in 2024.

Inflation was forecast to be 5.1% in 2022, 2.1% in 2023 and 1.9% in 2024. Although inflation was seen as rising, longer term inflation expectations nevertheless remained anchored near the 2% inflation target.

Based on this information, the Governing Council decided to expedite the reduction of net purchases under the APP by announcing a purchase schedule of EUR 40 billion in April, EUR 30 billion in May and EUR 20 billion in June. The future of the APP would be decided in the third quarter of 2022.

At its monetary policy meeting in April, the Governing Council noted that inflation had increased significantly, mainly because of a sharp rise in energy costs.

Based on this information, the Governing Council judged that net asset purchases under the APP should be concluded in the third quarter. In addition, the Governing Council assessed that it would continue to reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2024.

Key interest rates raised during the summer

In June, the Governing Council assessed that GDP growth would slow and inflation accelerate further in the immediate years ahead.

Eurosystem staff projections for GDP growth in the euro area were revised downwards for 2022 and 2023 but revised slightly upwards for 2024. The revised projections put real GDP growth at 2.8% in 2022, 2.1% in 2023 and 2.1% in 2024.

Inflation projections for 2022 and 2023 were revised upwards significantly as a result of soaring energy prices. However, inflation was expected to return to close to 2% over the medium term on account of moderating energy costs, the easing of supply disruptions and the normalisation of monetary policy. The revised projections showed inflation to be 6.8% in 2022, 3.5% in 2023 and 2.1% in 2024.

Based on this information, the Governing Council decided to end its net purchases under the APP already on 1 July 2022. APP reinvestments were planned to continue for an extended period of time past the date when the Governing Council started raising the key ECB interest rates.

The Governing Council also announced it was intending to raise the key ECB interest rates in July and September and also beyond September. This would mark the end of the Governing Council’s long-standing policy of low interest rates and commitment-based forward guidance.

In July, the Governing Council decided to raise the three key ECB interest rates by 0.5 percentage points to ensure the return of inflation to the 2% target over the medium term. It also concluded that further rate hikes would be necessary at its future meetings.

In addition, the Governing Council approved the Transmission Protection Instrument (TPI), a new monetary policy tool for supporting the effective transmission of monetary policy to the economy. The TPI can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across all euro area countries.

Interest rate hikes continued in the autumn

At its monetary policy meeting in September, the ECB’s Governing Council noted that inflation projections had been revised upwards for 2022 and 2023. Accordingly, inflation was projected to be 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.

The Governing Council observed that inflation will start to fall over time as the current drivers of inflation fade and the normalisation of monetary policy works its way through to the economy and to price-setting.

The ECB staff revised its GDP growth projections downwards for 2023. The revised projections for real GDP growth were 3.1% in 2022, 0.9% in 2023 and 1.9% in 2024.

Based on this information, the Governing Council decided to further raise the ECB key interest rates by 0.75 percentage points. In addition, it signalled the need for further rate hikes over several meetings. The pace of these hikes would be determined by incoming data and the evolving inflation outlook.

Following the raising of the deposit facility rate above zero, the Governing Council decided that the two-tier system for the remuneration of excess reserves was no longer necessary. It therefore decided to suspend the two-tier system.

At its monetary policy meeting in October, the Governing Council took the view that inflation was still far too high and would remain above target for an extended period. In September, euro area inflation reached 9.9%. 

Based on this information, the Governing Council raised the ECB’s key interest rates by 0.75 percentage points. It also noted that it would decide its future policy rate path meeting by meeting and on the basis of the evolving outlook for inflation and the economy.

The Governing Council also decided to adjust the terms of its TLTRO III operations. In addition, it decided that the remuneration of minimum reserves held by credit institutions with Eurosystem central banks would be set at the ECB’s deposit facility rate in order to align this more closely with money market conditions.

Monetary policy tightening continued at end of year

At its monetary policy meeting in December, the ECB’s Governing Council noted that inflation still remained far too high and would likely stay above target for an extended period.

According to the Eurosystem staff projections, the slowdown in euro area GDP growth would be short-lived, but growth would nevertheless remain subdued in 2023 and be significantly lower than had been projected in June.

Euro area growth was projected to recover only after prevailing headwinds had abated. The projections for real GDP growth were 3.4% in 2022, 0.5% in 2023, 1.9% in 2024 and 1.8% in 2025.

Eurosystem staff projections for inflation were revised significantly upwards from their June levels. In the revised projections, inflation was seen as reaching 8.4% in 2022, 6.3% in 2023, 3.4% in 2024 and 2.3% in 2025.

On the basis of this information, the Governing Council decided to raise all three key ECB interest rates by 0.50 percentage points. The Governing Council noted that on the basis of the Eurosystem staff projections, inflation will not be slowing in the desired manner and so further interest rate increases will have to be made. 

The Governing Council decided that from the beginning of March 2023, it will reduce its reinvestments of maturing securities purchased under the APP at an average monthly pace of EUR 15 billion until the end of June, and that the subsequent pace of reinvestments will be determined over time.