Last year’s IFS annual dinner took place at a time when policy rates in advanced economies reached their highest level in a long time. Inflation was moderating but core inflation remained high and the case to reduce the restrictiveness of monetary policy was not yet clear.
That picture has changed.
Disinflation has progressed in a broad-based manner and core inflation has also come down steadily. As the inflation outlook improved, key central banks, including the ECB, began to dial back the restrictiveness of monetary policy.
Monetary policy
Annual inflation in the euro area has fallen from 2.9% at the end of last year to 2.0% in October. Measures of core inflation have also come down.
However, economic recovery in the euro area is losing steam. Additionally, trade fragmentation and decoupling among large geopolitical blocs, with increased risks of trade tariffs, especially after the outcome of the US presidential election, does not bode well for open economies like that of the EU.
Against this backdrop, the ECB has begun to unwind some of the restrictiveness of its monetary policy stance, cutting its deposit facility rate to 3.25% by October and markets expect this to continue in December.
Maltese economy
The Maltese economy has benefited from the global disinflation process.
A year ago, HICP inflation and the core measure were close to 4%. By October it fell to 2.4%, while HICP excluding energy and food decreased to 2.2%, which are both broadly in line with Malta’s long-term average inflation.
Although economic growth in the first half of this year moderated when compared to 2023, it surprised on the upside. This partly reflects the continued, albeit declining, fiscal deficit and the limited pass-through of the tighter monetary stance to lending and deposit rates.
The transition to a more neutral monetary stance should support foreign demand going forward and mitigate somewhat the slower recovery outlook for the euro area. Meanwhile, domestic demand should continue to benefit from the catching-up of real wages and disposable income bolstered by the recently announced income tax savings and increases in social benefits.
In view of these factors, and the stronger than expected GDP growth in the first half of 2024, the Central Bank intends to revise up its growth projections.
Nevertheless, there are reasons to be cautious in the degree of optimism.
The inflation outlook remains sensitive to developments in commodity prices, productivity and firms’ ability to absorb future wage increases through profit margins.
The ongoing escalation of geopolitical tensions and trade protectionism could lead to renewed disruptions to global supply chains and higher import costs, which are of concern for Malta as a small open economy.
The transition to a climate neutral economy is likely to impact prices, although a preliminary analysis by Central Bank staff indicates that the impact of the extension of the EU’s Emission Trading System to maritime transport should be small.
While the green transition is likely to entail costs in the short-term, the benefits of such transition are not only environmental but are also economic in terms of reduced dependency on energy imports and exposure to the volatility of their prices.
Geopolitical tensions and trade protectionism could lead to renewed disruptions to global supply chains, higher import costs- Alexander Demarco
Furthermore, although the fiscal deficit is narrowing towards 3% and the debt ratio is still well below 60%, an economy running at virtually full employment for some years well into the post-pandemic period should not be recording fiscal deficits. Fiscal policy could be bolder going forward and the favourable growth prospects for the Maltese economy offer an opportunity to reprioritise public expenditure towards more vulnerable groups and initiatives that impact favourably productivity, innovation and the green and digital transitions.
Macro-financial developments
Financial stability conditions in Malta improved as the banking sector continued to maintain solid capital and ample liquidity positions. Profitability has risen notably, largely driven by higher net interest income. Revenue from intermediation also grew from robust credit dynamics, though predominantly driven by property-related activity, which raises concentration risk on banks’ loan portfolios.
However, the transmission of tighter monetary policy in Malta has been weak, and, together with the continued strong growth in tourism demand and employment, it is also contributing to sustain property-price inflation of around 7%.
Macroprudential policy has an important role to play in ensuring adequate resilience of the financial system, more so given the low pass-through of monetary policy. The Central Bank, therefore, stands ready to use such tools once again to ensure adequate resilience in our financial system.
As digitalisation and technological innovation proliferates, activities of the financial sector, including non-bank financial institutions, increasingly overlap. As the domains of finance and technology continue to blur, regulation is expanding beyond banking at the European level, which is now looking at implementing macroprudential tools also on non-bank financial institutions.
Some reflections on the local capital market and its potential to play a bigger role in funding the changing needs of Maltese firms is also merited. To realise this potential, capital markets require the trust and confidence of investors, which is also achieved by strengthening regulatory frameworks.
Introducing private debt issuer and issuance ratings should be a fundamental requirement to enable investors better assess whether yields are commensurate with the risk being taken and to establish a more level playing field in financial markets.
Similarly, sinking funds should be required to ensure private debt issuers have sufficient funds at redemption time, particularly in cases of rollover, or new issuances for re-financing purposes.
To conclude, as inflation is now sustainably closer to target and the restrictiveness of monetary policy eases, Malta is well-positioned for steady growth but should not remain complacent. Risks from geopolitical tensions, international trade fragmentation and property-centric credit growth locally highlight the need for careful monitoring.
While fiscal discipline and safeguarding resilience of the financial sector will be crucial to sustain economic stability, economic agents, including policymakers, need to keep their focus on measures and investments that impact positively productivity and innovation, which are, ultimately, the real source of sustainable economic growth and better living standards.
Alexander Demarco is the Acting Governor of the Central Bank of Malta.
The above article is a shortened version of the Governor’s speech at the Institute of Financial Services annual dinner.