Ladies and Gentlemen,
It is a great pleasure to be in London today for this OMFIF meeting and I am grateful for your kind invitation. By the way, today is history for our single currency, the euro: we announced this morning a decisive step toward future banknotes. We will have to decide between two possible themes by next year: culture, with six prominent Europeans, and rivers and birds. These banknotes will much better represent Europe, and embody the historically high support of 81% of European citizens for their single currency. That said, I would like to share with you some insights about two recent monetary developments. I will first comment on short-term rates and yesterday’s monetary policy decision (I) and then highlight some challenges against a backdrop of rising long-term rates (II).
I. On ECB short-term rates: a clear direction, and a pragmatic pace
Yesterday, our Governing Council, led by President Lagarde, decided unanimously a fifth cut, and a fourth in a row. Compared to other major central banks, ECB has been the earliest to cut, the lowest to go, and probably has the clearest path in its monetary course. To put it in a nutshell: as the ECB president said, we are precisely on track in our victorious fight against inflation. We know there is a discussion whether this success is the result of luck – reversal of commodity prices – or of central banks work. Both, to be honest: but monetary policy played its significant part. There are different models used by various European NCBs and the ECB itself: but all of them converge to a conservative estimate of monetary policy having reduced inflation by about 2% in 2023 as well as in 2024.
Looking ahead, we should be sustainably around our 2% inflation target by this summer. The French flash inflation in January published this morning, stable at 1.8% and slightly lower than expected, is good news on this road: services inflation in particular seems to be receding. We see significant wage deceleration and are hence confident on core inflation decrease, including services. And on activity, we avoided recession last year with 0.7% growth, and will again avoid it this year. But the somewhat disappointing GDP stagnation in Q4 published yesterday confirms that risks on growth are clearly tilted to the downside.
With such a “disinflationary slowdown”, the direction of the travel is clear: our monetary policy will go from restrictive towards neutral, and should support a gradual recovery while ensuring inflation is at our target. How fast and how far should we go in this travel? This is where what I call “agile pragmatism” and our data driven approach will guide us. I don’t want to bother you today with a sophisticated discussion about the precise level of R*… Furthermore, long term yields have increased, limiting the easing of overall financial conditions.
II. A more challenging view on long-term yields
A) Unusual divergence between short and long-term rates
The ECB, since last June, and the US Federal Reserve, since last September, began a rate cutting cycle and both have reduced their policy rates by 100 bp last year. But over the same period longer term yields have increased, particularly in the US which is very unusual compared to previous easing cycles. The US 10-year yield is now up by more than 80 basis points since the Fed started cutting rates and the so-called “Trump trade” began while previous easing phases were initially associated with a fall in long yields.
US Monetary Easing But Medium- To Long-Term Rates Increase