Suomen Pankki

European Central Bank’s monetary policy has dampened price pressures

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According to the European Central Bank’s (ECB) macroeconomic projections published in June 2024, the euro area economy is expected to grow this year by 0.9% and by 1.4% in 2025. Growth in the real incomes of households will bolster private consumption, and demand for the euro area’s exports will pick up. Faster growth in the economy will be aided by the still robust labour market.

Inflation in the euro area was at 2.6% in May and is projected to return to the ECB’s target in 2025. The ECB’s monetary policy has dampened price pressures, with inflation falling by more than 2.5 percentage points since the last increase in policy rates in September 2023. Core inflation has declined and inflation expectations have fallen.

Against this backdrop, the ECB’s Governing Council cut its policy rates in June by 0.25 percentage points. The new deposit facility rate is 3.75%. “It is important to see the forest for the trees. Considerable progress has been made in bringing inflation down to target, especially since September 2023,” says Governor of the Bank of Finland Olli Rehn. Financing conditions have been held tight in order to curb demand and to keep inflation expectations anchored.

The Governing Council aims to ensure that inflation returns to the 2% target in the medium term. “We set our rates at each Governing Council meeting based on three factors: the inflation outlook, the dynamics of underlying inflation and the strength of monetary transmission. And we are not pre-committing to any rate path,” says Governor Rehn. Assuming there are no new geopolitical or energy price shocks or unanticipated wage growth, inflation is expected to return to target during the year ahead, despite inflation’s downward path slowing somewhat in recent months.

In Finland, the structural difficulties in the economy have continued for some time, and productivity performance has been weak since the global financial crisis. These factors are weighing on Finland’s growth outlook. The global crises of the past few years have transformed Finland’s operating environment, and at the same time Finland’s share of world trade has decreased. The cessation of trade with Russia has raised the prices of production inputs, and not all of the lost trade has been replaced.

Even before Russia’s illegal war in Ukraine, Finland’s export industry had already experienced market share losses in world goods exports. “The composition of Finland’s export trade has not adapted to the structural changes occurring in world trade since 2000. In the longer run, competitiveness can only be improved on a sustainable basis by raising productivity,” says Rehn. Growth in the Finnish economy will also be held back by the ageing of the population.

It is necessary to support productivity development through public sector measures as well. When directing public funding, it is important to take into account that most innovations used in Finland have been produced elsewhere. “By investing in basic research and in related higher education, we strengthen our capacity to adopt innovations made elsewhere,” emphasises Rehn.

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The Bank of Finland is the national monetary authority and central bank of Finland. At the same time, it is also a part of the Eurosystem, which is responsible for monetary policy and other central bank tasks in the euro area and administers use of the world’s second largest currency – the euro.

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