The Bank of Greece Interim Report on Monetary Policy 2024
20/12/2024 - Press Releases
Today, in accordance with its Statute, the Bank of Greece submitted its Interim Report on Monetary Policy 2024 to the Speaker of the Greek Parliament and to the Cabinet.
Positive economic developments in an international environment of heightened uncertainty
The world economy remained resilient in 2024, despite restrictive monetary policies and the uncertainty relating to the ongoing conflicts in Ukraine and the Middle East. Headline inflation continued to decline significantly in advanced economies, also as a result of monetary policy tightening. However, services inflation remains high, hence the rate-cutting cycle on which monetary authorities in several economies embarked in 2024 is progressing with cautious steps. In any event though, global financial conditions are currently more favourable than twelve months earlier, world trade has rebounded and international commodity and energy prices have broadly stabilised. Still, uncertainty regarding the future of the global economy has increased significantly.
Regarding the euro area, although conjunctural indicators suggest that economic activity was marginally weaker than expected, the economy is recovering and is set to gather pace with time as higher real incomes allow households to consume more and as investment is expected to rebound. The gradual removal of monetary policy restriction is expected to support consumption and investment.
In the course of 2024, euro area headline inflation continued its downward path that had started in 2023, while most measures of long-term inflation expectations stand at around 2%. Against this backdrop, the Governing Council of the European Central Bank (ECB) lowered the deposit facility rate in June, September, October and December, by 25 basis points each time. The Governing Council has made clear that it is not pre-committing to a particular rate path.
The outlook for global and European GDP growth remains positive, but is subject to significant downside risks, related to mounting geopolitical uncertainty and a potential increase in trade protectionism. For the euro area in particular, recent political developments in large European economies are adding to the uncertainty.
Real economy: Sustained growth momentum – Slow disinflation process
Economic activity in Greece continued to grow at a robust pace in the first nine months of 2024 (2.3% year-on-year). The key driver of growth was domestic demand, mainly private consumption but also investment. Stronger consumption was supported by higher household incomes, as employment continued to rise and nominal wages increased markedly. Exports of services also showed positive developments. Yet, the contribution of net trade was marginally negative, as exports of goods were likely dampened by subdued foreign demand, while at the same time imports of goods and services rose considerably. Finally, lower government consumption made a negative contribution to GDP growth.
Headline inflation, as measured by the Harmonised Index of Consumer Prices (HICP), declined year-on-year, averaging 3.0% in the available eleven months of 2024, down from 4.2% in 2023. Turning to individual HICP components, food inflation and non-energy industrial goods inflation fell visibly during 2024 compared with the previous year. However, persistently high services inflation prevented a faster decline in headline inflation, which ended up higher in Greece than in the euro area.
Financial developments: More favourable financial conditions
Market-based inflation expectations in the euro area and the United States have been declining and have converged to the inflation targets of the ECB and the US Federal Reserve. In particular, as early as the end of the third quarter of 2023, investors anticipated interest rate cuts by major central banks worldwide. As a result, global financial conditions are now more favourable compared with one year earlier. In this context, government and corporate bond yields have declined, especially for shorter maturities, contributing to a significant improvement in financial conditions around the world. Yet, financial conditions could be adversely affected by increased international geopolitical and macroeconomic uncertainty.
Greek government bond yields have largely tracked developments in the other euro area sovereign bond yields. Meanwhile, Greece’s sovereign credit rating upgrades are leading to considerably stronger investor participation in new issues of Greek government bonds, supporting a continued decline in government borrowing costs.
2024 saw upgrades in Greek banks’ credit ratings. This reduces banks’ cost of borrowing from international capital markets, benefiting their net interest income. In the same vein, yields on bonds issued by Greek non-financial corporations have been declining since early 2024.
Share prices on the Athens Exchange (Athex) rose strongly until late October. The banking sub-index outperformed the Athex composite index, mainly in line with the Greek sovereign’s upgrade to investment grade, as well as banks’ increased profitability and credit rating upgrades.
Banking sector: Increased deposits, falling lending rates and stronger loan growth
Interest rates on time deposits, after trending upwards for about a year, remained almost unchanged in the fourth quarter of 2023 and in the first ten months of 2024 for most categories, despite the cuts in Eurosystem policy rates. Banks seem to delay adjusting their deposit rates probably to contain shifts from time deposit accounts into alternative investment options.
In the first ten months of 2024, the stock of private sector deposits increased by a cumulative EUR 0.7 billion, reflecting a recovery in business deposits, whereas the rise in household deposits was weaker. By October 2024, the stock of private sector deposits came to EUR 195.5 billion.
Bank borrowing costs for non-financial corporations (NFCs) and households have decreased this year, in line with Eurosystem policy rate cuts and an observed decline in banks’ funding costs on capital and bond markets.
Annual growth in bank loans to NFCs averaged 8.5% in January-October 2024, up from an average of 6.5% in 2023. Stronger credit expansion to businesses is associated with higher demand for bank loans, especially by large firms. Business credit was underpinned by the co-financing and loan guarantee schemes of development organisations, as well as by banks’ co-funded loans for investment projects under the Recovery and Resilience Facility (RRF).
Average annual growth in bank loans to households turned less negative in January-October 2024 (-1.1%), compared with an average of -2.4% in 2023. This development stemmed from housing loans, which declined at a weaker pace, and consumer credit, whose positive rate of change kept accelerating.
Banking system: Improved fundamentals
Banks’ fundamentals improved further over the first nine months of 2024. More specifically, liquidity and capital adequacy ratios improved, as did the quality of loan portfolios, while the profitability of banking groups remained satisfactory. These developments were supported by, among other factors, the robust performance of the Greek economy and the 2023 Greece’s sovereign credit rating upgrade to investment grade. As a consequence, rating agencies have recently upgraded the credit ratings of significant banks, maintaining a positive outlook.
The ratio of non-performing loans (NPLs) to total loans, on a solo basis, dropped considerably in September 2024 compared with December 2023, standing at its lowest level since Greece joined the euro area. This was due to actions aimed at cleaning up the loan portfolios of certain banks in the context of the upcoming inclusion of NPL securitisations in the Hellenic Asset Protection Scheme (HAPS), better known as “Hercules”.
Projections
According to the current projections of the Bank of Greece, GDP growth is expected to turn out at 2.3% in 2024, picking up to 2.5% in 2025 and moderating slightly to 2.3% in 2026 and 2.0% in 2027. Consumption is anticipated to be the key driver of growth, while investment and exports should continue making positive contributions. Overall, the contribution of net trade to GDP is projected to be slightly negative in the coming years, as buoyant investment activity and stronger consumption should lead to imports rising at broadly the same pace as exports.
Inflation, as measured by the Harmonised Index of Consumer Prices (HICP), is projected at 3.0% in 2024, down from 4.2% in 2023, reflecting a large slowdown in food inflation. By 2026, inflation should converge towards but remain slightly above the ECB’s target of 2%. Services inflation is set to be more persistent than other HICP components, mainly reflecting expected increases in labour compensation. Lastly, core inflation is projected to drop considerably to 3.5% in 2024 and 3.1% in 2025, mainly driven by falling non-energy industrial goods inflation.
Risks and uncertainties
Risks to the growth forecasts of the Bank of Greece are tilted to the downside and concern: (i) an aggravation of the geopolitical crisis in Ukraine and the Middle East and the implications for the global economic environment; (ii) increased trade protectionism worldwide; (iii) lower-than-expected absorption and utilisation rates for RRF funds; (iv) a tightening labour market and possible wage pressures; (v) slower-than-expected implementation of the necessary reforms; and (vi) possible natural disasters related to the climate crisis.
Progress
The Greek economy has accomplished remarkable achievements over the past years and has proven very resilient to several external shocks, such as the COVID-19 pandemic, the energy crisis and the war in Ukraine with the ensuing surge in inflation. The growth rate of the Greek economy has been outpacing the EU average since 2019, accelerating the convergence of Greece’s real GDP per capita with the average European level. Employment is on the rise and the unemployment rate has fallen to single-digit levels despite a substantial increase in the minimum wage. As a consequence, disposable income is rising and the share of population at risk of poverty or social exclusion decreased between 2019 and 2023. The prudent fiscal policy pursued over the past years and the efforts to combat tax evasion are bearing fruit, as high primary surpluses are generated without a need for austerity measures and the public debt-to-GDP ratio is declining.
The solid economic performance in recent years has resulted in Greece’s sovereign credit rating upgrade to investment grade. A further confirmation of the progress achieved so far is the recent credit rating upgrade of Greek government bonds by Scope Ratings to BBB from BBB-.
Challenges
Greece’s achievements in recent years indicate that the economy is on the right path. However, the effort to recover from the 10-year debt crisis has yet to be completed. In real terms, both GDP and GDP per capita still fall short of pre-crisis levels, and their catching up with the European averages requires even stronger growth rates.
Furthermore, several domestic structural weaknesses, some of which pre-dating the debt crisis, linger on. For instance, lack of competition in a number of economic sectors, which adds to the international high cost of living problem; high public debt; a large investment gap; low saving; weak structural competitiveness that worsens the current account balance; low labour force participation of women and youth, as well as ageing population, which both increase labour market tightness over time, remain a drag on the economy’s growth dynamics.
Such domestic weaknesses are compounded by global challenges, such as the intensification of geopolitical confrontations, geo-economic fragmentation and a renewed trade protectionist trend, the climate crisis, energy security, the transition to a sustainable and circular economy, as well as the advent of new digital technologies and of artificial intelligence (AI) in particular.
Policy recommendations
In light of the above, economic policy should remain committed to safeguarding fiscal credibility and stability, as well as to the implementation of the necessary investments and reforms under the National Recovery and Resilience Plan “Greece 2.0”, which will facilitate the green and digital transition and speed up growth in the years ahead. This would, at the same time, ensure a gradual improvement in the Greek economy’s credit rating.
Nevertheless, although timely absorption and effective use of RRF funds are key determinants of the economy’s path going forward, this alone does not suffice to recoup the ground lost as a result of the 10-year debt crisis. Additional actions are therefore needed to address the Greek economy’s inherent weaknesses and achieve sustainable growth rates.
Indicatively, demographic ageing is expected to shrink the working age population. This calls for active labour market policies and education and training programmes aimed to raise female and youth labour force participation. Also, targeted policies are required to integrate immigrants into the labour force and attract foreign workers, so as to address labour shortages already observed in agriculture, tourism-related sectors and construction.
Given the constraints posed by demographic developments, it is necessary to enhance labour productivity in order to maintain the growth momentum. Key to higher labour productivity is an increase in investment, which requires the full absorption and productive use of the available EU funds. At the same time, it also requires a strengthening of the banking sector and its ability to tackle the existing challenges and effectively finance investment and economic growth. Vigilance is therefore warranted, so as to further clean up banks’ assets and avert new net inflows of non-performing loans. In this connection, a diversification of the sources of financing, through a wider use of microcredit and access to alternative types of market-based funding, is important for meeting the investment needs of small and medium-sized enterprises (SMEs), in particular start-ups and innovative SMEs, that do not have sufficient tangible assets to offer as collateral for obtaining bank credit.
In view of the environmental and climate change-related challenges, increasing total factor productivity becomes crucial, as it would help maintain or raise living standards, while at the same time protecting natural resources and the environment.
Enhancing total factor productivity requires an improvement of education and training especially in new technologies, with a view to increasing human capital. Moreover, labour and capital markets should operate in a way to ensure allocative efficiency, by channelling labour and capital inputs into the more productive firms in an industry, enabling them to thrive, while the less productive ones exit the market. Allocative efficiency leads to higher total factor productivity and economic growth. By contrast, economic growth and productivity would gradually decline if labour and capital remained with relatively non-productive firms. This could occur if e.g. the labour market is overly regulated, if favourable provisions or barriers to market entry allow non-viable firms to remain in business, or if new, more dynamic firms face difficulties in accessing finance.
Meanwhile, addressing other issues that hamper the efficient allocation of resources is of vital importance for long-term growth. Such issues include the complexity and poor quality of legislation, delays in the delivery of justice, an unclear spatial planning framework, inadequate connection of education with the labour market, infrastructure deficiencies, high cost of electricity, a heavy tax burden on labour income and high indirect taxes.
Furthermore, the Greek economy’s extroversion must be enhanced, as firms’ access to the global market enables them to benefit from economies of scale and increase their technology content, while international competition tends to reward the most productive businesses.
In addition to the above, total factor productivity gains can also stem from higher firm-level productivity through technological, organisational and process innovation. Thus, firms adopting state-of-the-art technologies and attracting top talent can greatly improve their productivity. Beyond actions by businesses themselves, government interventions are also needed, in the form of subsidies and tax incentives to foster an innovation ecosystem in which businesses, research institutes and universities can work together to promote the conduct, as well as commercialisation, of basic research.
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To sum up, enhancing total factor productivity through reforms and innovation, alongside increases in investment and labour force participation, is crucial for boosting economic growth and raising living standards. Yet, although as a country we must remain committed to the implementation of the required reforms, the response to the new global trends and challenges cannot possibly come from any single country alone. Rather, there is a need for a common approach, a joining of forces and cooperation at the European level, along the lines suggested by the recent Letta report on the necessity of completing the Single Market and the Draghi report on the future of EU competitiveness. A key prerequisite for closing the innovation, productivity and competitiveness gaps and for safeguarding the sovereignty, security and resilience of Europe is coordination and joint action by Member States, also building on the successful experience with the NextGenerationEU recovery instrument.
The full text of the Report is available (in Greek) here.