'It’s great to be back at Analysis, and it’s great to be back in Italy. As some of you may know, I’ve had a love affair with your country ever since my time as a student in Pavia, 34 years ago. Although I must say that it’s also a bit of a relief to be away from the Netherlands for a few days. Because, well... this is more or less what my country looks like right now.

I love football, I really do. But this is a bit too much even for me. Thankfully, we always have monetary policy to talk about.

Of course, I realise that most of you are probably preoccupied by tonight’s game against Spain. But please spare me your attention for just a few minutes. So let’s kick off.

Two weeks ago the ECB decided to lower its policy rate by 25 basis points.

The question everyone is asking: at what pace and up to what point will the ECB continue its descent from restrictive territory? How will our monetary policy evolve in the short and longer term?

The simple answer is that we’re sticking to our data-dependent approach. The three criteria that we used when inflation was on the way up will remain relevant on the way down. They are: the inflation outlook in the light of incoming data; the dynamics of underlying inflation, and the strength of monetary policy transmission.

Let me go through these three criteria one by one.

First, the inflation outlook. Looking at our latest forecast, inflation is expected to reach our target of 2% by the end of next year. Forecast errors have also become smaller, which allows us to be more confident in our outlook. Moreover, inflation data show we are well underway in the disinflation process. Inflation has come down from a peak of over 10% to below 3% currently. That being said, the recent uptick in the May inflation figures reminds us that this process is bumpy and will remain so, at the least for the rest of this year.

Let me now turn to the second criterion that guides our policy, the dynamics of underlying inflation. Core inflation has come down, again with some hiccups. Meanwhile, most other indicators of underlying inflation have also eased. At the same time, services inflation and, related, wage growth, which you can see on the chart, remain above levels consistent with our 2% inflation target. So here, not all the signs are green yet.

Finally, regarding monetary policy transmission, our 450 basis points of rate hikes have been transmitted very forcefully into lending rates. You can see this in the graph on the left, which shows the interest rate on new bank loans for households and businesses. In terms of transmission there may even still be something in the pipeline, as existing loans are being refinanced. Also, credit growth has come down substantially and is now hovering around zero, as you can see on the right.

So, based on these three criteria, we reached our decision two weeks ago to cut our policy rate by 25 basis points. And these criteria will continue to guide our monetary policy stance in order to ensure that inflation returns to target in a timely manner and inflation expectations remain anchored.

This way of conducting monetary policy can be summarised in one short sentence: wait for incoming data, including new projections, and then decide accordingly. It sounds really simple. But as Dutch football legend Johan Cruijff once said in his inimitable football Latin: football is very simple, but the most difficult thing there is, is playing simple football. The same is true for monetary policy. Because underneath this seemingly simple framework and its guiding criteria, we are confronted with uncertainties that make forecasting inflation and calibrating policy far from simple.

For one thing, despite 25 years of institutional history, we have little experience with a gradual easing of monetary policy following a tightening cycle.

Moreover, every cycle is different, particularly since the global economy has undergone important structural changes in the macroeconomic, financial and policy domains over the past decades.

Another reason is that we are currently in an environment characterized by high uncertainty, as you can see in the graph, which makes the assessment of inflation drivers particularly challenging. This high uncertainty reflects the high frequency of large shocks, in particular on the supply side, as well as geopolitical risks and structural changes in the economy that are difficult to capture in our models. These include de-globalisation, demographics, digitalisation, climate change. In particular, we need to better understand the dynamics of labour markets and their drivers.

So what policy conclusions for the short term can we draw from this?

The inflation projections that I just mentioned imply a 'soft landing': we expect inflation to return to target in a timely manner and without triggering a major economic downturn. Basically, you could say the score is one-nil – we have taken the lead.

With this outlook, monetary policy can 'play defensively'. Here I mean that our policy decisions can help facilitate this projected inflation path to materialize, rather than trying to shift this path in any direction. It’s a bit like following the tactics of the legendary Giovanni Trapattoni.

At the time of the latest inflation forecast, a little under three rate cuts were priced in for 2024 by financial markets. Would such a path make sense? One way to assess this in a more formal way is to look at so-called 'optimal' policy scenarios which are based on analysis conducted by DNB. These optimal scenarios are derived from models in which monetary policy tries to minimize deviations of inflation from target and output from its potential.