Monetary policy tightening has proved effective and is instrumental in curbing euro area inflation

The Oesterreichische Nationalbank (OeNB) presents its financial statements and Annual Report for 2023

„Faced with a difficult environment for monetary policymaking, the Eurosystem – and the OeNB as a its member – stayed the course in 2023. In view of elevated inflation, we continued to exit from accommodative policies and gradually raised key interest rates. In 2023, geopolitical conflicts and wars resulted in big political and economic challenges. In 2024, on top of the ongoing armed conflicts, elections are coming up in a number of major economies. Other challenges that persist for the economy, politics and, in fact, society at large, are the digital tech transformation, climate change, energy transition and demographic change,” Robert Holzmann, Governor of the Oesterreichische Nationalbank (OeNB), said today during the presentation of the OeNB’s 2023 financial statements and Annual Report.

To dampen high inflation in the euro area, the Governing Council of the ECB has been gradually raising key interest rates since 2022. The interest rate hikes made in 2023 continued to affect the profitability of the Eurosystem central banks, including the OeNB.

The OeNB’s negative operating result for 2023 reflects an asset liability mismatch. In other words, the interest expense the OeNB paid for commercial banks’ deposits exceeded the interest income it received from the fixed but currently significantly lower yields on the securities it had purchased under the asset purchase programs. Commercial banks’ deposits are recorded on the liability side of the OeNB's balance sheet, the securities on the asset side.

„Whether central banks generate a profit or loss comes second to the mandate on which we have to deliver. Maintaining price stability over the medium term is the objective that the Eurosystem and the Governing Council of the ECB pursue with their policy decisions,“ Governor Holzmann explained.“ On occasion, this may mean that central banks end up disclosing unfavorable results for some periods, like the negative operating result the OeNB arrived at in 2023,“ OeNB Executive Director Thomas Steiner seconded.

Importantly, such developments and losses do not impair the OeNB's financial standing, nor do they compromise its ability to take action. The OeNB continued to fulfill all of its tasks in an effective manner in 2023. Apart from monetary policy, these comprise especially safeguarding financial stability, securing the smooth functioning of payment systems operating on Eurosystem market infrastructures, providing cash, producing top-quality statistics and preparing for a digital euro.

Total assets decreased, with operating result negative for the first time

„Monetary policy has also been the key driver of total asset growth,” Thomas Steiner summed up the development of the OeNB's balance sheet and profit and loss account.

Total assets and total liabilities dropped by EUR 13 billion or 5% year on year, mainly as a result of monetary policy operations on both sides of the balance sheet. On the asset side, the balances outstanding under targeted longer-term refinancing operations (TLTROs III) continued to shrink significantly, from EUR 39 billion to EUR 15 billion, as operations matured or banks opted for early repayment. TLTRO III funding had been offered by the Eurosystem at three-year maturities from fall 2019 to December 2021, with strong take-up from Austrian credit institutions. On the liability side of the balance sheet, commercial banks’ deposits were also on the decline.

Ultimately, the OeNB ended up recording an operating loss of –EUR 2,211 million. This is a first, and mainly due to net interest income. Net interest income totaled –EUR 2,043 million in 2023, which is a sharp deterioration from 2022. This deterioration is essentially due to the aforementioned asset liability mismatch. In other words, it is attributable to the spread between the fixed low yield of securities held for monetary policy purposes (EUR 494 million) on the asset side, and mounting interest expense given the prevailing deposit facility rate (–EUR 3,476 million) on commercial banks’ deposits held on the liability side. Beyond that, the OeNB’s result was driven further into negative territory by interest expense on the OeNB’s TARGET balances (–EUR 2,633 million). This compares with EUR 2,066 million of interest income from the remuneration of intra-Eurosystem balances arising from the allocation of euro banknotes within the Eurosystem, and EUR 1,092 million of interest income from longer-term refinancing operations (TLTROs III).

The OeNB’s income from other sources, including its reserve investments, was above average but still insufficient to compensate for the negative net interest income. Like last year, the OeNB is therefore not in a position to pay out a profit share to the Austrian central government. From today’s perspective, the financial burden resulting from the monetary policy-related asset liability mismatch is here to stay for some years, which means that it is going to affect the OeNB’s financial result also in the years ahead. The OeNB’s first balance sheet loss of EUR 2,062 million, attributable to monetary policy operations, will be carried forward to the financial year 2024, to be offset by future profits. This is why the OeNB will not be making any profit distributions to the central government in the coming years either. „As a central bank, the OeNB differs from companies and commercial banks, and it has been tasked by law with a clear mandate: The primary objective of the Eurosystem is to secure price stability. Losses have no impact on the ability to conduct effective monetary policy,” Executive Director Steiner emphasized.

Austria’s economy in recession in 2023

Economic output in Austria had started to decline somewhat in the second half of 2022, on account of three factors: (1) pent-up demand from the COVID-19 pandemic was running out, (2) energy prices were going up and (3) the international environment was weak. In the second and third quarters of 2023, output then fell unexpectedly sharply and Austria slipped deeper into recession. The main drivers were marked drops in private consumption and investment, accompanied by a decline in exports. In late 2023, the dampening factors weakened and household incomes were increasingly supported by higher wage agreements. As a result, output growth stagnated in the fourth quarter of 2023. In sum, Austria’s real GDP shrank by 0.7% in 2023.

Looking ahead, the OeNB expects quarterly GDP growth rates to be slightly positive in 2024. The recovery is mainly driven by strengthening consumer demand; by contrast, investment is likely to contract further in 2024. We expect the Austrian economy to grow moderately by around ½% in 2024, despite a weak start. Those are the latest projections, generated by the OeNB’s interim economic forecast of March 2024.

Key interest rates in the euro area raised to 4% in 2023

In 2023, monetary policymakers were up against the task of taking adequate monetary policy action to keep already elevated consumer prices from rising even higher, after inflation in the euro area as a whole had peaked at 8.4% in 2022. In 2023, inflation was going down: Monthly inflation rates as measured by the Harmonised Index of Consumer Prices (HICP) fell from 8.6% in January to 2.9% in December. Euro area inflation thus averaged 5.4% in 2023. The Eurosystem’s macroeconomic projections, as updated in March 2024, point to inflation rates of 2.0% for 2025 and 1.9% for 2026.

To bring inflation down, the Governing Council of the ECB raised the key interest rates six times in 2023, from 2% to 4%. By the end of 2023, the interest rate on the main refinancing operations in the euro area stood at 4.50%, the interest rate on the marginal lending facility was 4.75%, and the interest rate on the deposit facility was 4.00%.

However, it took more than the policy rate hikes to bring inflation down. By 2023, it had also become necessary to reduce the Eurosystem balance sheet, and hence also the OeNB’s balance sheet. This is because large central bank holdings of securities dampen the level of medium to long-term interest rates. The Eurosystem’s and the OeNB’s monetary policy securities portfolios currently consist mainly of assets acquired under the asset purchase programme (APP) and the pandemic emergency purchase programme (PEPP). In 2023, the Eurosystem started to shrink the APP portfolio at a measured pace, and the reduction will be continued in 2024. As of July 2023, maturing securities under the APP have no longer been replaced. In 2023, the OeNB’s portfolio of APP assets thus decreased by EUR 3.8 billion, to EUR 71.6 billion. Meanwhile, the PEPP portfolio worth EUR 37.3 billion was sustained in full, in line with Eurosystem policy. That is to say, the principal payments of maturing securities were reinvested in full. This approach will be kept up in the first half of 2024. In the second half, the PEPP portfolio is expected to start to shrink moderately. As decided on December 14, 2023, the Governing Council of the ECB intends to discontinue reinvestments under the PEPP at the end of 2024. Last but not least, in 2023, the OeNB’s total assets also declined due to the unwinding of TLTRO III refinancing operations.

Inflation markedly down in Austria

In Austria, HICP inflation peaked at 11.6% in January 2023. Thereafter, it gradually declined to 4.2% in February 2024. Our analysis shows that, in 2022, inflation was mainly driven by energy and other import prices. In late 2022, corporate profits had emerged as the key cost driver. From the second quarter of 2023, wages were accounting for roughly half of the price increases. As a result, the impact of nonenergy services and industrial goods on inflation increased, whereas the impact of energy and food prices was on the decline in 2023. This trend is expected to continue in 2024. According to our March 2024 forecast, we expect inflation to drop from 7.7% in 2023 to 3.6% in 2024, to 2.7% in 2025 and to 2.3% in 2026. And we project core inflation to exceed HICP inflation throughout the forecast horizon.

Resilient Austrian banking system holding steady amid challenging conditions

„The Austrian banking system has become increasingly resilient thanks to steady microprudential supervision at the solo level and thanks to macroprudential measures aimed at enhancing systemic stability. In light of this, it continues to rank among the eleven most stable banking systems in the world,“ explained OeNB Vice Governor Gottfried Haber.

In 2023, banks were operating under challenging conditions, given armed conflicts, geopolitical tensions, elevated inflation, economic weakening and in particular banking turmoil in the USA and Switzerland. „Clearly, the manifold challenges and new risks that have emerged in recent years have driven home the benefits of forward-looking and targeted micro- and macroprudential banking supervision,“ Vice Governor Haber pointed out.

Austrian banks not only mastered these challenges thanks to strengthened balance sheets, but they also managed to attain high profitability amid rising interest rates. A solid capital and liquidity base remains of the essence, and even more so in times of uncertainty. After all, the positive effects of the key interest rate hikes were felt immediately, while the negative effects in terms of deteriorating credit quality and the ensuing increase in risk costs and credit defaults occur only with a certain time lag.

Vice Governor Haber added that „despite a difficult environment, the macroprudential measures were key in enhancing the perception of the Austrian banking sector and contributed to its top rating. S&P ratings therefore continue to rank the Austrian banking sector among the most stable in the world. This means that Austrian banks benefit from favorable refinancing costs, which they can pass on to their customers. By extension, the central and regional governments only pay low interest on their public debt.”

In 2023, the OeNB stepped up its external communication on the riskiness of variable rate loans, after having closely monitored this type of loan for some time. In Austria, variable rate loans account for a significant share in financing. Even from mid-2015 to mid-2022, their share averaged out at 45% of newly originated housing loans to households. That is, during a period in which long-term interest rates were very low. At the end of 2023, their share again exceeded 50%. Variable rate loans harbor interest rate risk for borrowers. They put additional financial burdens on households in a situation, like we had in 2023: interest rates were on the rise and a weak economic environment caused real incomes to shrink. Austria’s Financial Market Stability Board (FMSB) likewise explicitly highlighted the particular riskiness of variable rate loans in 2023.

Borrower-based measures had been introduced in Austria already in August 2022, following international standards and recommendations. Since then, the lending standards for residential real estate loans have been improving markedly in Austria. For this reason, the risks related to residential real estate loans to households did not adversely affect financial stability when households, feeling the financial squeeze, faced a higher financial burden and real estate prices for the first time started to contract again.

True to proactive supervision, microprudential and macroprudential supervisors continued in 2023 to keep close tabs on loans taken out to finance commercial real estate. The commercial real estate market was weighed down by several factors, namely rising interest rates, increased construction costs, shrinking real estate prices and the generally weak economic conditions. As a result, the banking sector recorded an increase in associated write-downs and credit losses, which were thoroughly analyzed and subject to inspections at both the systemic and the solo level. The supervisory focus on commercial real estate is set to continue also in 2024.

In 2024, banking sector profitability is likely to suffer from weaker credit growth, rising refinancing costs, e.g. on account of higher deposit rates, and deteriorating credit quality. In addition, banks are feeling the cost pressure of inflation. Accordingly, Vice Governor Haber advised banks „to continue strengthening their capital base by using the high profits they earned in 2023 and to pay out dividends in a prudent, forward-looking and restrained manner.“

In the statistics area, it is of note that, last year, the OeNB launched a transparency platform for savings account rates that compares the conditions offered by Austrian banks. We cooperated closely with representatives from Austrian banks and the Austrian Economic Chambers, which helped us implement the platform in a very short time frame. The platform provides a market overview of interest rates for overnight deposits as well as for deposits with lock-in periods of 6, 12, 24 and 36 months. Users may determine at a glance whether their savings products match the current market conditions. The transparency platform is thus a first step in helping people optimize their investments, to be followed up by deeper dives on private and public comparison portals and by negotiations with their bank or other credit institutions.

OeNB initiative to secure access to cash

„Austrians continue to strongly favor cash,” confirmed OeNB Executive Director Eduard Schock. What they appreciate above all about cash is that it is an anonymous, resilient and secure means of payment. This is why some 95% of the domestic population cannot imagine a world without cash – notwithstanding the fact that digital payments have been becoming increasingly popular.

In line with its obligation to supply cash, the OeNB stands ready to meet the still high demand for euro banknotes. Above all, this also means ensuring continued free access to cash for cash users in Austria and leaving it at their discretion, as in the past, which payment instrument to use.

Cash in Austria continues to be highly accessible, with the network of automated teller machines (ATMs) remaining dense by international standards.

Nevertheless, it will take a dedicated effort to ensure that cash remains accessible throughout Austria also in the future. As a case in point, the number of ATMs has been going down by close to 6%, or some 500 machines, since 2021.

„It will take extra efforts to secure and sustain today’s excellent infrastructure. The OeNB for its part spares no efforts to proactively safeguard the continuous supply of cash,“ Executive Director Schock confirmed.

In 2023, we launched the „Bargeld-Board”, which brings together officials from domestic banks to discuss strategic issues related to the supply of cash. The OeNB’s latest initiative is a „basic cash supply model,” to be negotiated with the banking community until the summer of 2024. Rather than focusing on absolute numbers of ATMs, this model has been designed to ensure reasonably local ATM access. The idea is to make sure ATMs will be within a reach of 1 kilometer for 67% of the population, within 2 kilometers for about 83% of the population, and within a radius of no more than 5 kilometers for 97% of the population.

Preparations for the digital euro underway

The Eurosystem considers issuing a digital euro. Just like euro cash, a digital euro would be issued, protected and regulated by the ECB, and would thus be equally trustworthy. Governor Holzmann made the case for a digital euro, pointing out that „central banks must ensure that money remains a public good and monetary policy remains independent. The idea is to make a digital euro available for day-to-day payments, as a digital form of central bank money that exists alongside cash and private sector payment instruments. It is meant to be a new affordable option for how to pay, for people in the euro area and beyond. Moreover, a digital euro is set to strengthen the euro area’s monetary sovereignty. A strategically autonomous Europe would not depend on payment systems provided by non-European institutions, which may be of the essence in times of crisis.”

The green light for moving into the preparation phase for the digital euro was given in mid-October 2023. In early 2024, the ECB already published the first calls for tender related to the issuance of a digital euro. The OeNB has committed itself to helping develop the technical components, alongside other Eurosystem central banks. „By the end of 2025, the digital euro project might be taken to the next level by the Governing Board of the ECB,” Governor Holzmann explained.

OeNB focuses on sustainable governance

In line with its corporate strategy, the OeNB attaches great importance to sustainability. Clearly, the only way forward for both the OeNB and its subsidiaries is to ensure sustainable business operations and to help protect the environment. The OeNB keeps an eye on how its activities impact on society and the environment – with a view to promoting sustainable development both in Austria and beyond. „As pledged in 2021, the OeNB as an institution aims to be carbon neutral by 2040 and to adjust its investment strategy accordingly until 2050,” Governor Holzmann noted. „At present, we cooperate closely with international bodies to develop metrics and instruments to achieve the respective targets.”

 

At the end of the press conference, Governor Robert Holzmann thanked the President, the Vice President and the other members of the General Council for their dedicated contributions. On behalf of the OeNB’s General Council and Governing Board, he also thanked all members of staff for their ongoing outstanding commitment.