A sharp increase in geopolitical tensions and the resulting economic uncertainty characterised the operating environment of the Bank of Finland and the entire Eurosystem in 2023. Central banks curbed inflation by tightening their monetary policy. The effects of higher interest rates were felt in the financial and housing markets.

In brief

Geopolitical tensions and economic uncertainty

In 2023, Russia’s war in Ukraine and the trade disputes between the United States and China continued, and the Middle East crisis came to a head in Gaza. These fuelled supply disruptions and trade wars and affected the energy and financial markets. These factors also accelerated inflation and slowed economic growth.

Inflation and tighter central bank monetary policy

The euro area economy was hampered by rising inflation and weaker economic performance in 2023. Like many other central banks, the European Central Bank (ECB) tightened its monetary policy in order to curb price pressures. Inflation did then slow down in the euro area during the course of the year. Globally, monetary policy tightening had a considerable impact on world trade, also reducing aggregate demand in the euro area due to its subdued export markets. With euro area domestic demand also being muted, the economic outlook weakened extensively in 2023.

Monetary policy tightening was transmitted forcefully in Finland

In 2023, the Finnish housing and real estate markets were particularly strongly affected by rising interest rates, as were the loan servicing costs of businesses and households. Inflation eroded purchasing power, and export demand was muted. The Finnish economy slid into recession and the unemployment rate rose. Public finances suffered from the growing deficit and debt level.

Geopolitical tensions accelerated inflation

Geopolitical tensions increased and the global economy became more fragmented in 2023

In 2023 there was great uncertainty in the economic environment, which was fuelled by the various global crises occurring in succession and by geopolitical tensions.

Russia’s war in Ukraine was already in its second year. In Europe the energy sector encountered disruptions and price increases. The war which broke out in Gaza in the Middle East also created uncertainty towards the end of 2023 and, among its other impacts, it affected international freight traffic.

International conflicts, trade wars and political disputes caused disruptions to international trade, energy markets and financial markets. Trade wars led to higher tariffs and hampered supply chains, productivity and economic growth, and fuelled inflation.

In 2023, the trade tensions especially between the United States and China also contributed to global economic fragmentation, i.e. the division into competing blocs.

Monetary policy tightening and the euro area’s economic challenges

Central banks curbed inflation and tightened their monetary policy in 2023

Efforts to control inflation and maintain financial stability faced a wide range of challenges in 2023 due to global uncertainties.

Many central banks around the world tightened their monetary policies in order to alleviate the price pressures which had spread to the energy and commodity markets, and from there to other parts of the economy.

Euro area economic performance weakened in 2023. Heavy industry, in particular, was in great difficulty due to rising energy and raw material prices. Weak economic growth globally, and particularly in China, also strained the export outlook.

The economy also lacked support from domestic demand, as inflation eroded consumers’ purchasing power and the high interest rates dampened construction and investment.

At the beginning of 2023, the annual inflation rate in the euro area was still 8.6%, but this fell steadily throughout the year. Monetary policy tightening reduced demand and eased price pressures. The stabilisation of energy prices was also a major factor contributing to the fall in inflation to 2.9% in December 2023. The annual inflation rate for the whole of 2023 was 5.4%.

End of rise in market rates in the euro area

In 2023, the rise in longer term market interest rates came to an end in the euro area financial markets. Market rates started to decline at the end of the year, as the market anticipated that the ECB would start cutting policy rates during 2024. German 10-year bonds approached a peak of 3% in the autumn, but were at about 2% at year end. The closing level was 0.5 percentage points lower than at the end of 2022.

At the close of 2023, the German 2-year rate was at the same level as the beginning of the year, at around 2.5%. For countries with a lower credit rating, the 10-year yield spreads against Germany narrowed throughout 2023, especially in Greece. Finland’s corresponding yield spread against Germany remained unchanged in 2023 (approximately 0.5 percentage points).

On the money market, the 12-month Euribor rose by 0.2 percentage points to 3.5% during 2023. The euro strengthened against the US dollar by 3%, with a year-end exchange rate of USD 1.10. The gold price in euros rose by around 10%, reaching a new nominal peak of nearly EUR 1,900 per ounce at the end of the year.

The euro area equity market had a good year, as interest rate expectations started to decline towards the end of the year and the economic news was favourable, especially in the United States. Euro area equities rose by 14% as measured by the EURO STOXX Index. However, the broad OMX Helsinki Index declined by 7%. Finnish equities slid down due to lacklustre domestic economic performance and an unfavourable sectoral distribution.

Weak performance in Finnish economy in 2023

Finnish economy slid into recession in 2023

The Finnish economy slid into recession in 2023, with gross domestic product (GDP) contracting by 1.0% from the previous year. The reasons for this included the impact of inflation on purchasing power, the tighter financing conditions and the weak performance of export markets. GDP was nevertheless bolstered by the positive figure for net exports as a result of imports declining by more than exports. Finland’s cost competitiveness weakened in relation to the euro area.

There was also a broad decline in domestic demand. Consumer confidence was weak, and private consumption contracted by 1.0% from the previous year. The steep increase in interest rates, the rapid rise in costs for businesses and waning demand caused a reduction in residential and non-residential investment.

Because of the weak cyclical conditions, the labour market situation also deteriorated in 2023. The unemployment rate rose to 7.2% and the number of hours worked decreased slightly. However, the employment rate remained fairly good, and many sectors were still suffering from labour shortages.

The fiscal deficit grew to 2.5%, while the final-quarter figure for general government debt rose to 75.8% of GDP.

Higher interest rates reduced investment appetite in Finland in 2023

In 2023, higher interest rates raised the debt servicing costs of businesses and households and made new loans more expensive than before. Changes in money market rates were quickly transmitted to lending rates in Finland, as short-term market rates are widely used by banks as reference rates for mortgages and corporate loans.

Higher interest rates reduced the willingness of households and businesses to take out loans and make major investments.

A slowdown was evident in housing and real estate transactions, in particular. The number of housing transactions was substantially below normal in Finland. The transaction volume increased at the end of the year, when the Government enacted changes to the asset transfer tax arrangements for housing transactions.

Record drop in housing prices in Finland in 2023

The prices of existing dwellings in housing companies in Finland declined by about 10% between June 2022 and December 2023 – the biggest drop since the economic and banking crisis of the early 1990s. The fall in housing prices was especially marked in the Helsinki metropolitan area and in the major cities.

Although the steep decline in the number of new residential construction starts continued in 2023, there were also a large number of completions of previously started projects. The number of bankruptcies among construction companies was higher in 2023 than in 2009, the year following the global financial crisis.

Despite the weakness in the economy, Finnish households and businesses for the most part coped with their higher loan servicing costs.

Finnish banks’ credit losses increased only a little. The profitability and capital adequacy of the banks even improved, as higher interest rates expanded their net interest income.

Resilience of the financial system and critical payment systems put to the test

International banking system’s resilience withstood the turbulence caused by rising interest rates

In the international financial markets, the most dramatic consequences of the rise in interest rates  were seen in March 2023, when the California-based Silicon Valley Bank failed because of its excessive liquidity risks. Shortly afterwards, the Swiss banking giant Credit Suisse, which had long been in difficulty, was sold to its rival.

However, the market turmoil remained short-lived mainly due to the prompt action taken by the US authorities and the robust resilience of the international banking system.

Preparations for payment disruptions and elevated risks continued in 2023

In 2023, payment systems in Finland functioned reliably for the most part and without any major disruptions, despite the strained geopolitical situation.

The Bank of Finland aims to ensure the continued operation of financial market services critical for society, such as payments, during any serious disruptions occurring in normal times, and in exceptional circumstances. With this in mind, backup arrangements were developed further, and drills and testing were increased in 2023. See the Act on Certain Backup and Emergency Arrangements in the Financial Sector (666/2022) (in Finnish).

At the same time, the ECB’s extensive system reforms progressed. The Bank of Finland participated actively in these.

The update of the Eurosystem’s retail payments strategy in 2023 supported the priorities of the Bank of Finland’s own operations in regard to promoting preparedness and single European payments. Progress was made with the Commission’s regulatory initiatives concerning the availability of instant payment options to everyone, clarification of the definition of legal tender, and euro cash and a digital euro.

Climate change and biodiversity loss pose risks to the financial sector as well

Climate change was seen and felt tangibly during 2023, with an abundance of extreme weather events around the world and new temperature records being set.

The Synthesis Report of the UN Intergovernmental Panel on Climate Change (IPCC) published in March 2023 noted that the climate has already warmed by 1.1 °C from pre-industrial levels. It was still felt to be possible to limit warming to 1.5 °C, but this would require critical measures.

A unanimous agreement for a transitioning away from fossil fuels was reached at the United Nations Climate Change Conference (COP28) held in Dubai in late November and early December.

In 2023, increasing attention was given to biodiversity loss as a key environmental challenge. Both climate change and the decline in biodiversity pose risks for the economy and the financial sector.

It is essential that central banks assess the impacts of these changes and of transitioning to a carbon-neutral society, so that they can take these into account when safeguarding price stability and the stability of the financial sector.

Data and technology are shaping the operations of central banks

The fourth industrial revolution, namely the huge transformation under way through digitalisation and technology, is profoundly changing the operating environment. The significance and use of data of all kinds is emphasised strongly in this new environment.

The Bank of Finland and the FIN-FSA must keep abreast of developments. The Bank and the FIN-FSA established the Analytics Center of Excellence in 2023, which supports the more effective use of data science, provides peer support and facilitates the development and uptake of new methods. The first information strategy of the Bank of Finland and the FIN-FSA was approved in the latter part of 2023. The information strategy supports a joint data economy promotion project, which will be launched in early 2024.