Monetary policy in 2023
The Eurosystem, comprising the European Central Bank (ECB) and the national central banks of the euro area, is responsible for conducting monetary policy in the euro area. The Bank of Finland participates in the preparation of and decision-making on the Eurosystem’s single monetary policy and is responsible for its implementation in Finland.
In brief
Objectives and measures
The main objective of the Eurosystem is to keep euro area inflation at 2% over the medium term. As inflation was significantly above this target at the start of 2023, monetary policy decisions focused on bringing it down.
Implementation and results
The Governing Council of the ECB tightened its monetary policy a number of times during 2023. The most important measures were interest rate increases and reductions in purchase programmes and refinancing operations. Inflation was 8.6% in January and 2.9% in December.
Climate change considerations in monetary policy implementation
In 2023, the Eurosystem published for the first time a report on climate-related disclosures of its corporate securities holdings purchased for monetary policy purposes. The disclosures, prepared in line with international reporting recommendations, increase transparency about the Eurosystem’s monetary policy measures.
Monetary policy stance in 2023
The main objective of the Eurosystem is to keep euro area inflation at 2% over the medium term, in line with the ECB’s new monetary policy strategy published in 2021. As inflation was significantly above target at the start of 2023, the Governing Council of the European Central Bank (ECB) tightened its monetary policy during the year, particularly by raising interest rates and scaling down purchase programmes and refinancing operations.
The Governing Council is responsible for taking decisions on monetary policy in the euro area. The Governing Council consists of the six members of the ECB’s Executive Board and the governors of all the euro area national central banks, including the Governor of the Bank of Finland, Olli Rehn. During Rehn’s leave of absence in autumn 2023, his place on the Governing Council was taken by Member of the Board of the Bank of Finland Tuomas Välimäki.
The Governing Council takes decisions on the key ECB interest rates and asset purchase programmes at its monetary policy meetings. These decisions are supported by analyses and forecasts of developments in the financial markets and the economy, prepared by experts from the ECB and the Eurosystem. The ECB’s Governing Council held eight monetary policy meetings in 2023.
Euro area inflation was high at the start of 2023, and the ECB’s monetary policy decisions focused on bringing it down.
The Governing Council tightened its monetary policy a number of times during 2023. Inflation fell from 8.6% in January to 2.9% in December as a result of declining energy prices, tighter monetary policy and weaker demand (Chart 3). Long-term inflation expectations have stayed close to the ECB’s inflation target of 2%.
Changes in key ECB interest rates
The ECB has tightened its monetary policy particularly by raising its key interest rates (also known as its policy rates) and reducing the size of its balance sheet.
Monetary policy is calibrated on the basis of the latest data, and during 2023 the key ECB interest rates were raised six times and by altogether 2 percentage points.
In February and March, the Governing Council decided to raise the key rates by 0.50 percentage points. Smaller rate hikes of 0.25 percentage points followed in May, June, July and September. At the last meetings of the year – in October and December – the policy rates were kept unchanged.
The ECB’s most important policy rate, the deposit facility rate, was raised from 2.00% to 4.00% in 2023. The interest rate on the main refinancing operations was raised from 2.5% to 4.50%, and the rate on the marginal lending facility from 2.75% to 4.75%. Read more on the ECB’s interest rate decisions.
The ECB’s deposit facility rate increases were rapidly and fully passed on to the money market. The Governing Council facilitated this by deciding in February 2023 to lower the ceiling for the remuneration of non-monetary policy deposits.
In July, the Governing Council decided to set the remuneration of minimum reserves at 0% in order to improve the efficiency of monetary policy.
Asset purchases and size of the central bank’s balance sheet
The ECB curbed inflation in 2023 not only by raising interest rates but also by reducing the size of its balance sheet. This occurred through reduced reinvestment of maturing securities and via the maturities of refinancing operations.
This process of reducing the balance sheet, or quantitative tightening (QT) of monetary policy, was executed passively by letting the balance sheet shrink as targeted longer-term refinancing operations (TLTROs) matured and as bonds acquired under monetary policy purchase programmes matured and were no longer reinvested in full.
Full reinvestments of the principal payments from maturing securities purchased under the asset purchase programme (APP) were continued until the end of February 2023.
In March 2023, in line with its earlier notification, the ECB started to reduce the size of the APP portfolio by allowing the securities to mature without replacing them. At its meeting in June 2023, the Governing Council decided to discontinue the reinvestments under the APP.
With respect to the pandemic emergency purchase programme (PEPP), reinvestments of the principal payments from maturing securities were continued throughout the year.
In December 2023, the Governing Council decided that full reinvestments of the principal payments from maturing securities under the PEPP would only be maintained up to the end of the first half of 2024.
Over the second half of 2024, PEPP holdings will be allowed to shrink by EUR 7.5 billion per month on average. PEPP reinvestments are intended to be discontinued completely at the end of 2024.
The Eurosystem’s APP holdings decreased from EUR 3.254 trillion to EUR 3.026 trillion in 2023.
The ECB publishes the Eurosystem’s PEPP holdings every two months. At the end of November 2023, the value of PEPP holdings was EUR 1.660 trillion, a decrease of EUR 23 billion compared with a year earlier.
The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.
As necessary, the ECB may also activate the Transmission Protection Instrument (TPI) to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area.
No new targeted longer-term refinancing operations (TLTROs) have been conducted since 2021. Most of the targeted refinancing operations have already matured, and this has contributed to reducing the Eurosystem’s balance sheet. Banks have also voluntarily made early repayments of the TLTRO funds borrowed. All the remaining TLTROs will mature by December 2024.
With the reduction in outstanding TLTROs, the demand for financing by banks in the one-week main refinancing operations (MROs) and the three-month longer-term refinancing operations (LTROs) increased slightly in 2023 but nevertheless remained very low.
The outstanding amount of Eurosystem refinancing operations decreased in 2023 by EUR 1.323 trillion, to EUR 410 billion. As a consequence, the amount of collateral deposited with the Eurosystem also decreased to an average of EUR 1.900 trillion in 2023 (-28%).
The gradual phasing out of the pandemic collateral easing measures decided by the ECB Governing Council in 2022 continued in 2023 by raising the valuation haircuts for all eligible assets to the pre-pandemic level on the basis of the Eurosystem’s updated risk assessment.
During the period of banking turbulence in March 2023, the ECB, together with other major central banks, temporarily increased the frequency of US dollar liquidity-providing operations. However, the demand in these operations remained low.
The Eurosystem’s balance sheet shrank by about EUR 1.000 trillion to approximately EUR 7.000 trillion in 2023, due to the maturing of both monetary policy securities and TLTROs. Excess liquidity in the euro area banking system, in turn, decreased by around EUR 500 billion, to EUR 3.500 trillion.
Monetary policy preparation in 2023
The Bank of Finland is an influential member of the Eurosystem and expresses its views on the basis of data, research and high-quality analysis. These principles guide the preparatory work on monetary policy at the Bank of Finland and in the Eurosystem’s Monetary Policy Committee and its working groups. Experts from the Bank of Finland are extensively involved in the activities of the Committee and its working groups.
The preparatory work on monetary policy at the Bank of Finland is overseen by the Monetary Policy Preparation Process, which is a group of experts combining expertise from the Bank’s various departments. It is responsible for preparing recommendations for the Bank of Finland Governor in support of the Governor’s role in monetary policy decision-making in the ECB Governing Council and in related policy discussions.
The expert group is also tasked with analysing structural issues concerning the monetary policy environment and related conditions and providing support for Finnish and international communication on monetary policy.
In 2023, the focus of monetary policy preparation was on the application of the ECB’s new monetary policy strategy and on the transmission of monetary policy in the new inflation environment, taking into account country-specific differences, indebtedness and fiscal implications.
Analysis work carried out by the Bank of Finland in 2023 focused especially on inflation dynamics and measures to bring high inflation down to the target level, and on the development of the ECB’s new operational framework for implementing monetary policy.
Analysis and forecasting of euro area economic growth and inflation are an integral part of monetary policy preparation
Before each monetary policy meeting of the ECB, the Bank of Finland draws up a comprehensive analysis of the euro area economy, covering the particular trends and developments in the real economy, prices and financial markets that are relevant to the ECB’s monetary policy.
The analysis makes extensive use of topical statistical data, nowcasting models for forecasting economic growth and employment, and the continuously improving inflation models.
On the basis of this analysis, Bank of Finland experts formulate a view on inflation and economic growth in the euro area, in support of monetary policy preparation.
Euro area analysis takes into account analysis of the global economy
The Bank of Finland Institute for Emerging Economies (BOFIT) analyses major economies outside the euro area and conducts research on the macroeconomy and the financial markets.
BOFIT has traditionally focused on Russia and China, and these also featured prominently in the institute’s work in 2023. For both economies, BOFIT published two forecasts and also regular weekly reviews.
Topics discussed in BOFIT’s publication series included the impacts of Russia’s illegal war in Ukraine, the effects of sanctions on Russia’s economy, dependency on China and the potential fragmentation of the global economy into blocs.
Monetary policy preparation is also supported by academic research
In 2023, the Bank of Finland continued its high-quality research, which supports the preparatory work on monetary policy in a variety of ways and helps understand the transmission of monetary policy. High-quality research also increases the Bank of Finland’s impact and influence, and the interest shown towards it as a potential partner, both in Finland and internationally.
Researchers from the Bank of Finland published more than 20 peer-reviewed research articles in 2023 on various topics in areas such as monetary policy, financial markets and the international economy. The articles discussed, for example, the term structure of interest rates, monetary policy at the zero lower bound and central bank forward guidance.
New research projects and findings were also presented to a wide audience of experts in the Bank of Finland’s own Research Discussion Paper series and BoF Economics Review series and, for example, in columns on the VoxEU platform and in the SUERF Policy Briefs. Among the topics discussed were the effectiveness of unconventional monetary policy instruments, the pass-through of negative interest rates to loan rates, the effectiveness of monetary policy in an ageing society and the interest rate elasticity of private consumption.
New research contributions have also been regularly presented at international conferences and the Eurosystem’s committees, working groups and research networks.
Each year, the Bank of Finland co-organises various conferences and thematic sessions for its partners. The co-organisers include the Centre for Economic Policy Research (CEPR), the European Money and Finance Forum (SUERF, Société Universitaire Européenne de Recherches Financières) and the Central Bank Research Association (CEBRA). In spring 2023, the Bank of Finland also organised for the first time an international financial literacy conference. The specific themes of the conference were financial literacy gaps and the cost of living crisis. In addition, the Bank hosted a research cluster workshop focusing on financial stability and macroprudential policy in the Eurosystem. The workshop was held in Saariselkä, Lapland.
Forecast for the Finnish economy is part of the euro area macroeconomic projections and monetary policy preparation
The preparation of euro area monetary policy and analysis of the effects of that policy necessitate independent and analytical assessment of the economy covering the immediate years ahead.
There is often a time lag between the introduction of monetary policy measures and their impact on inflation and other macroeconomic phenomena. For this reason, monetary policy decision-makers need an informed view of how decisions taken now would affect the economy many months or even years ahead.
The Bank of Finland draws up forecasts primarily to support the preparation of the euro area’s single monetary policy and the related decision-making, and the forecast for the Finnish economy is therefore produced as part of the Eurosystem’s macroeconomic projections. The macroeconomic projections are also closely linked to the forecast for the public finances and to the short-term inflation forecast.
Each year, the Bank of Finland publishes four forecasts for the Finnish economy. Two of these, in June and December, are extensive forecasts drawn up in cooperation with the Eurosystem. A considerably more limited interim forecast is published in March and September. The forecasts are drawn up using macroeconomic statistical models. The Bank of Finland’s December 2023 forecast had three key messages (Chart 6).
Participation of the Bank of Finland in domestic economic policy debate in 2023
Bank Finland provides topical and independent analysis and expertise for use by decision-makers and in Finnish society in general. It also participates in the domestic debate on economic policy, in particular through its comments and statements and via speeches given by its Board members. The views expressed by the Bank of Finland are based on the objectives set for it by law and in the EU Treaties and also on its independent status.
The Bank of Finland’s key contributions on domestic economic policy in 2023 were the Governor’s speech at a stakeholder event on 21 April, the Governor’s speech at the opening seminar of the government formation talks on 2 May, the editorial of the Bank of Finland Bulletin published on 20 June, the editorial of the Bank of Finland Bulletin published on 19 December and the Governor’s public hearing in Parliament’s Commerce Committee on 6 October.
The main themes raised by the Bank of Finland in the domestic economic policy debate in 2023 were the sustainability of the public finances, strengthening the conditions for long-term economic growth, and the transmission of monetary policy tightening to the Finnish economy.
In December 2023, the Bank of Finland’s assessment of the public finances was gloomier than in the previous year. General government revenue and expenditure are structurally out of balance. According to the Bank of Finland’s December 2023 estimate, the sustainability gap in Finland’s public finances was approximately 4.5% of gross domestic product (GDP), and the debt ratio was projected to rise to over 80% by 2026.
Finland’s long-term growth prospects are also undermined by the unfavourable trend in the labour market. Labour productivity growth has been slow since the beginning of the 2010s. While the employment level has been supported by a rise in the labour force participation rate, the number of hours worked per employee has been falling for a long time. At the same time, the rise in young people’s educational attainment level has halted.
Monetary policy tightening rapidly affected both households and businesses in 2023. Households’ loan servicing costs increased, because the majority of mortgages in Finland are variable rate loans.
As Finland’s industrial structure is more heavily weighted towards manufacturing and construction, this also increases the economy’s sensitivity to interest rate changes. The impact of these factors and the overall economic growth impact of having the same monetary policy in all euro area countries were together clearly more important in 2023 than the extent to which interest rates are variable or fixed among the loan stock.
Over the course of 2023, the Bank of Finland stressed that debt sustainability should be taken as a common economic policy priority and a firm commitment made to ensuring this across parliamentary terms. It is important to not only pursue fiscal consolidation but also ensure the conditions for sustainable economic growth through long-term economic policy that supports innovations and their utilisation.
Monetary policy implementation and its preparation in 2023
Bank of Finland’s monetary policy counterparties grew in number in 2023
The Bank of Finland’s monetary policy counterparties comprise Finnish credit institutions and branches of Nordic banks operating in Finland. Monetary policy counterparties are required to be subject to financial supervision, to be financially sound and to hold a minimum level of reserves. They must also fulfil the operational requirements set by the Bank of Finland.
At the close of 2023, the Bank of Finland had 20 counterparties, compared with 16 the previous year.
This increase was due to the Bank of Finland’s decision in 2023 to supplement its operational requirements with an option for counterparties wishing to have access only to the overnight deposit facility of the standing facilities. The operational requirements are more relaxed under this option than if the counterparty is also granted access to collateralised credit operations.
The Bank of Finland considered that a wider use of the overnight deposit facility would support monetary policy transmission in an environment of abundant liquidity and a positive deposit facility rate.
Monetary policy counterparties are required to comply with the Bank of Finland rules on monetary policy operations and collateral, which were updated three times during 2023.
Bank of Finland counterparties made substantial repayments of refinancing operations in 2023
The volume of credit provided by the Bank of Finland to its counterparties in refinancing operations decreased during 2023 from about EUR 30.1 billion to approximately EUR 3.7 billion in 2023 (Chart 8).
In 2023, banks’ demand for financing in the weekly main refinancing operations (MROs), the three-month longer-term refinancing operations (LTROs) and the US dollar liquidity operations was very low, both via the Bank of Finland and in the Eurosystem as a whole.
Consequently, as in recent years, outstanding refinancing operations consisted almost entirely of targeted longer-term refinancing operations (TLTROs). The outstanding volumes shrank, however, as no new TLTROs were conducted in 2023 and the amounts borrowed earlier decreased due to maturity and early repayment.
With the repayment of refinancing operations, the amount of collateral deposited by counterparties with the Bank of Finland decreased by 39% in 2023, to an average value of about EUR 24 billion.
However, the amount of collateral deposited did not shrink in the same proportion as the amount of credit. As a consequence, the amount of excess collateral from Bank of Finland counterparties increased by 60%, to an average of 46% in 2023. Excess collateral is the portion of the collateral deposited with the Bank of Finland which is in excess of the outstanding amount of monetary policy loans.
Covered bank bonds and credit claims were the most common asset classes used as collateral among the Bank of Finland’s counterparties, accounting respectively for 60% and 26% of all collateral pledged, (Chart 9). Among the asset classes used as collateral, credit claims also saw the biggest growth (7 percentage points), as the amount of credit claims decreased the least.
With the reduction in outstanding refinancing operations and purchase programme holdings, the amount of liquidity deposited with the Bank of Finland by institutions required to hold a minimum level of reserves also decreased during the course of 2023, from EUR 140 billion to EUR 122 billion (-13%, Chart 10).
The liquidity deposited with the Bank of Finland remained relatively stable in proportion to the liquidity deposited across the Eurosystem.
Counterparties’ liquidity holdings mainly consisted of overnight deposits, which are remunerated at the Eurosystem’s deposit facility rate. As the year progressed, counterparties minimised their current account balances exceeding the minimum reserve requirement, which are remunerated at 0%, and made active use of interest-bearing overnight deposits.
Bank of Finland’s purchase programme holdings started to decrease in 2023
Guided by the ECB’s monetary policy objectives, the Bank of Finland purchased Finnish public sector debt securities, Finnish covered bonds and a broad range of corporate bonds in 2023.
The Bank of Finland itself bears the risk in public sector securities purchases, but the risks in the private sector purchase programmes are shared among the Eurosystem’s central banks.
In 2023, holdings of monetary policy-related securities on the Bank of Finland’s balance sheet decreased from EUR 96 billion to EUR 90 billion. Of this total, securities purchased under the APP amounted to EUR 63 billion, and under the PEPP to EUR 28 billion.
At the end of 2023, the amount of Finnish government bonds and government-related bonds purchased under the APP on the Bank of Finland’s balance sheet totalled EUR 35.2 billion, and bonds issued by European supranational institutions amounted to EUR 1.7 billion.
Holdings of Finnish central government bonds are published by Statistics Finland on a quarterly basis in the national financial accounts. At the end of September 2023, the Bank of Finland held 32.4% of the total stock of Finnish central government bonds.
At the end of 2023, the amount of corporate bonds purchased under the APP on the Bank of Finland’s balance sheet totalled EUR 14.9 billion, and covered bonds amounted to EUR 10.6 billion.
The aim of securities lending is to support the liquidity of euro area bonds.
Bank of Finland participated actively during 2023 in the review of the operational framework for implementing monetary policy
In December 2022, the ECB Governing Council announced it would be reviewing its operational framework for implementing monetary policy.
The operational framework is used for controlling short-term money market rates. In the context of the framework review, a timetable is also envisaged for bringing the Eurosystem’s balance sheet back to its normal size.
Experts from the Bank of Finland participated actively in the related planning and discussion in the Eurosystem’s working groups and committees and at the ECB Governing Council.
You can read more on the subject in the following articles:
How will the European Central Bank control interest rates in the future?
Monetary policy implementation in a landscape of rising interest rates and a shrinking Eurosystem balance sheet (speech by Board Member Tuomas Välimäki)
The size and composition of the balance sheet will differ depending on the operational framework. The ECB’s operational framework review is due to be concluded in spring 2024.
Incorporation of climate change considerations into the monetary policy framework progressed in 2023
In the context of the monetary policy strategy review in 2021, the ECB Governing Council decided on an action plan for incorporating climate change considerations into the Eurosystem’s monetary policy framework.
The Governing Council added detail to the action plan in 2022 to account for climate risks in the areas of corporate bond purchases, the collateral framework, risk management and sustainability disclosures.
In order to incorporate climate risks into corporate bond purchases, the Eurosystem introduced in October 2022 an issuer-specific climate score which, together with other risk management aspects, tilts bond purchases towards issuers with a better climate performance.
The overall climate score for an issuer takes into account the issuer’s emission levels, decarbonisation targets and climate disclosures. In implementing monetary policy, the climate score has a significant impact on the maximum purchase volumes of corporate-specific bonds, and in this way reduces the climate-related risks in the Eurosystem’s balance sheet.
In 2023, the Eurosystem published for the first time a report on its climate-related disclosures of corporate securities holdings purchased for monetary policy purposes. The disclosures, prepared in line with international reporting recommendations, increase transparency about the Eurosystem’s monetary policy measures.
The report discusses the governance, strategy, risk management and climate targets and metrics related to corporate sector asset purchases. It also presents the climate stress testing framework and its various climate scenarios used for assessing the longer term impacts of transition risks and physical risks on the Eurosystem’s holdings of corporate sector securities.
In 2023, the Bank of Finland also continued its preparatory work to incorporate climate-related risks into the Eurosystem’s collateral framework.
