Economic and monetary developments

Overview

At its monetary policy meeting on 7 September 2017, the Governing Council assessed that while the ongoing economic expansion provides confidence that inflation will gradually head to levels in line with its inflation aim, it has yet to translate sufficiently into stronger inflation dynamics. The economic expansion, which accelerated more than expected in the first half of 2017, continues to be solid and broad-based across countries and sectors. At the same time, the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability. Measures of underlying inflation have ticked up slightly in recent months but, overall, remain at subdued levels. Therefore, a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to gradually build up and support headline inflation developments in the medium term. The Governing Council thus maintained its monetary stance and will decide in the autumn on the calibration of the policy instruments beyond the end of the year.

Economic and monetary assessment at the time of the Governing Council meeting of 7 September 2017

The euro area economic expansion is continuing and becoming increasingly resilient, with the ECB’s monetary policy measures supporting domestic demand. Euro area real GDP increased by 0.6%, quarter on quarter, in the second quarter of 2017, after 0.5% in the first quarter. Real GDP growth is supported primarily by domestic demand. Private consumption is underpinned by employment gains, which are also benefiting from past labour market reforms, and by increasing household wealth. The recovery in investment continues to benefit from very favourable financing conditions and improvements in corporate profitability. Surveys and short-term indicators confirm the outlook for robust growth momentum in the near term.

The broad-based global recovery will support euro area exports. Global economic activity is projected to accelerate moderately, underpinned by continued monetary and fiscal policy support in advanced economies and a recovery in commodity-exporting emerging market economies. After showing a marked improvement at the turn of the year, global trade has softened recently, but leading indicators continue to signal positive prospects. Overall, the broad-based global recovery will mitigate the potential impact on exports of a stronger exchange rate, which has appreciated by 3.4% in trade-weighted terms since the Governing Council’s monetary policy meeting in June.

The September 2017 ECB staff macroeconomic projections for euro area real GDP growth are 2.2% in 2017, 1.8% in 2018 and 1.7% in 2019. Compared with the June 2017 Eurosystem staff projections, the expected growth rates have been revised up for 2017 and are broadly unchanged thereafter. Risks surrounding the euro area growth outlook remain broadly balanced. On the one hand, the current positive cyclical momentum increases the chances of a stronger than expected economic upswing. On the other hand, downside risks continue to exist, primarily relating to global factors and developments in foreign exchange markets.

According to Eurostat’s flash estimate, euro area annual HICP inflation in August 2017 was 1.5%, up from 1.3% in July. This reflected higher energy and, to a lesser extent, higher processed food inflation. On the basis of current oil futures prices, annual rates of headline inflation are likely to temporarily decline towards the turn of the year, mainly reflecting base effects in energy prices, before rising again.

While measures of underlying inflation have ticked up moderately in recent months, they have yet to show convincing signs of a sustained upward trend. According to Eurostat’s flash estimate, HICP inflation excluding energy and food was 1.2% in August, unchanged from July, but 0.4 percentage point higher than the average for the final quarter of 2016. Domestic cost pressures, notably from labour markets, are still subdued. Underlying inflation in the euro area is expected to rise gradually over the medium term, supported by the ECB’s monetary policy measures, the continuing economic expansion, and the corresponding gradual absorption of economic slack and rising wages.

The September 2017 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation at 1.5% in 2017, 1.2% in 2018 and 1.5% in 2019. Compared with the June 2017 Eurosystem staff macroeconomic projections, the outlook for headline HICP inflation has been revised down slightly, mainly reflecting the recent appreciation of the euro exchange rate.

The euro area budget deficit is foreseen to decline further over the projection horizon (2017-19) owing to improving cyclical conditions and decreasing interest payments. Based on the September 2017 ECB staff macroeconomic projections, the general government deficit ratio for the euro area is expected to fall from 1.5% of GDP in 2016 to 0.9% of GDP in 2019.Structural deficits, however, are not declining, despite the favourable growth dynamics.

Money growth remained robust despite some monthly volatility. The recovery in the growth of loans to the private sector has been proceeding. At the same time, the annual flow of total external financing to non-financial corporations is estimated to have eased somewhat in the second quarter of 2017.

The pass-through of the monetary policy measures put in place in recent years continues to significantly support borrowing conditions. Euro area sovereign bond yields have remained broadly unchanged since the Governing Council’s monetary policy meeting in June. Corporate bond spreads vis-à-vis the risk-free rate have declined marginally and remain below the levels observed in early March 2016 when the corporate sector purchase programme was announced.


Monetary policy decisions

Taking into account the outcome of the economic analysis and the signals coming from the monetary analysis, the Governing Council concluded that a continued very substantial degree of monetary accommodation is needed to secure a sustained return of inflation rates towards levels that are below, but close to, 2%. The Governing Council decided to keep the key ECB interest rates unchanged and expects them to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases. Regarding non-standard monetary policy measures, the Governing Council confirmed that the net asset purchases, at the current monthly pace of €60 billion, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. The net purchases are made alongside reinvestments of the principal payments from maturing securities purchased under the asset purchase programme (APP). In addition, the Governing Council reconfirmed its commitment to increase the APP in terms of size and/or duration if the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation. This autumn the Governing Council will decide on the calibration of the policy instruments beyond the end of the year, taking into account the expected path of inflation and the financial conditions needed for a sustained return of inflation rates towards levels that are below, but close to, 2%.


External environment

The global economy is continuing to expand at a solid rate. After a temporary dip in momentum in some countries at the start of the year, data point to a rebound in global GDP growth. Looking ahead, global economic activity is projected to accelerate moderately, underpinned by continued monetary and fiscal policy support in advanced economies and a recovery in commodity-exporting emerging market economies. After showing a marked improvement at the turn of the year, global trade has softened recently, but leading indicators continue to signal positive prospects. Global inflation is expected to rise as spare capacity at the global level diminishes.

Global economic activity and trade

The global economy has continued to expand steadily. Following a temporary dip in growth in some economies in the first quarter, the latest data and survey‑based indicators show a rebound in global growth. With regard to advanced economies, GDP growth rebounded in the United States in the second quarter, as consumer spending and inventories recovered from previous weak outcomes, supported by the tightening labour market and strong household confidence. In Japan, activity grew strongly in the second quarter supported by a favourable external environment and fiscal stimulus. By contrast, activity in the United Kingdom remained relatively muted, as household incomes were affected by rising inflation and falling real wages. With regard to emerging market economies, in Brazil and Russia, activity has been supported by the rebound in growth following deep recessions, while economic growth remained resilient in India and China.

Survey indicators suggest sustained global growth in the near term. The global composite output PMI (excluding the euro area) rose in August to just above the long-term average. The survey indicates the fastest pace of expansion since early 2015 (see Chart 1). Sentiment survey indicators have also risen over the past few months.

Chart 1

Global composite output PMI

(diffusion index)

48 50 52 54 56 58 2011 2012 2013 2014 2015 2016 2017 global global long-term average advanced economies emerging market economies

Sources: Haver Analytics, Markit and ECB staff calculations.
Notes: The latest observations are for August 2017. “Long-term average” refers to the period from January 1999 to August 2017.

Global financial conditions remain supportive overall. Equity markets in advanced economies were broadly unchanged over recent weeks amid subdued volatility and low risk aversion. Long-term interest rates in the United States and United Kingdom have moderated in the past couple of months. In Japan, yields were stable, reflecting the Bank of Japan’s yield curve control programme. Financial conditions in emerging market economies are also benefitting from expectations of a brighter global growth outlook amid resilient capital flows. In China, financial conditions have eased somewhat after a period in which authorities tightened financial conditions substantially in an effort to curb leverage in the financial system.

Monetary policies remain accommodative in advanced economies, and central banks in some emerging market economies have lowered their interest rates. In line with market expectations, the Federal Reserve System increased interest rates at its June meeting. It also announced the intention to start normalising its balance sheet later this year. However, markets continue to price in a very gradual monetary tightening in the United States, while central banks in other advanced economies are expected to maintain their accommodative stance. Among emerging market economies, some commodity-exporting countries lowered their policy rates, as inflation pressures subsided and exchange rates firmed.

Looking ahead, global economic activity is projected to accelerate gradually. The outlook amongst advanced economies is for a modest expansion, underpinned by continued monetary and fiscal policy support, as the cyclical recovery continues and output gaps close gradually. Amongst emerging market economies, the outlook is supported by resilient growth in China and India, and the recovery of commodity-exporting countries from significant adverse shocks to their terms of trade. Nonetheless, the pace of global expansion will remain below pre-crisis rates, which is consistent with estimates suggesting that the growth potential has declined across most advanced and emerging market economies in recent years. One of the factors behind this slowdown has been the weakness in capital contributions. Box 1 elaborates on the factors underlying subdued investment in advanced economies.

In the United States, activity is expected to strengthen. The recent depreciation of the US dollar and the pick-up in global growth are expected to boost the contribution of net exports to growth. Gains in housing and equity prices, coupled with buoyant consumer confidence and tight labour market conditions should all strengthen consumption spending further. With companies reporting improved earnings and solid business confidence, investment is projected to increase at a steady pace. However, market expectations of a smaller fiscal stimulus will provide less impetus to economic activity than previously foreseen. Moreover, in the near term there is some uncertainty about the impact of hurricane Harvey on economic activity in affected regions.

In the United Kingdom, real GDP growth is expected to remain relatively muted in the near term. Although the depreciation of the pound sterling is likely to support exports, the increase in inflation will lower real household incomes and private consumption. Heightened uncertainty about the United Kingdom’s future trade arrangements is also weighing on investment.

In Japan, accommodative policies continue to support expansion. In the near term accommodative monetary policy and the fiscal stimulus programme should support domestic demand, while exports gradually recover as external demand improves. Further ahead, however, activity is projected to decelerate towards its potential as fiscal support wanes and economic slack diminishes. Moreover, despite robust job creation, wage increases have remained modest, dampening private consumption prospects.

In China, activity continues to expand at a robust pace, supported by resilient consumption and the buoyant housing market. While fiscal policy should continue to be supportive, the focus of authorities on also containing financial stability risks is expected to underpin a gradual rebalancing as investment slows.

Central and eastern European countries benefit from strong consumption and investment, the latter supported by EU structural funds. Although inflation is foreseen to increase gradually, reflecting the fading effects of energy price falls, real disposable income is forecast to support GDP growth on the back of a further strengthening of the labour market and growth in wages.

The large commodity-exporting countries are continuing their recovery following deep recessions. In Russia, the rebound in activity since the start of the year is likely to continue, supported by oil prices, a benign external environment and an accommodative monetary policy. Consumption should improve at modest rates in response to rising real wages and growing consumer confidence, albeit from very low levels. Fiscal challenges will continue to weigh on growth. Economic activity in Brazil is expected to benefit from stabilising business confidence, improving terms of trade and loosening financial conditions. At the same time, recurring political uncertainties and fiscal consolidation needs continue to weigh on the medium-term outlook.

Growth in global trade slowed during the second quarter, but leading indicators continue to signal positive prospects. The volume of global goods imports increased by 0.5% quarter on quarter in the second quarter of 2017, which was below the pace of the previous quarter (see Chart 2). The slowdown in trade in merchandise was driven mainly by emerging market economies. Leading indicators, however, signal a positive outlook for global trade in the near term, with the global PMI for new export orders rising in August. Looking further ahead, world trade is projected to expand broadly in line with global activity.

Chart 2

World trade in goods

(left-hand scale: three-month-on-three-month percentage changes; right-hand scale: diffusion index)

46 48 50 52 54 56 58 60 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 2011 2012 2013 2014 2015 2016 2017 world trade (left-hand scale) world 1991-2007 average (left-hand scale) global PMI manufacturing excluding euro area (right-hand scale) global PMI new export orders (right-hand scale)

Sources: Markit, CPB and ECB calculations.
Note: The latest observations are for August 2017 (PMIs) and June 2017 (trade).

Overall, global growth is projected to increase gradually over the period 2017‑19. According to the September 2017 ECB staff macroeconomic projections, world real GDP growth (excluding the euro area) is projected to accelerate from 3.2% in 2016 to 3.7% in 2017 and 3.8% in 2018-19. Growth in euro area foreign demand is forecast to increase from 1.6% in 2016 to 4.7% in 2017, followed by growth of 3.4% in 2018 and 3.5% in 2019. Compared with the June 2017 projections, global GDP growth is largely unrevised, with downward revisions to prospects in the United States reflecting expectations of a smaller fiscal stimulus, which is offset by a brighter outlook in some emerging market economies. Growth in euro area foreign demand has been revised upwards for 2017, reflecting stronger import data in the first quarter.

The uncertainty surrounding the baseline projections for global activity remains elevated, with the balance of risks tilted to the downside. On the upside, there is a possibility that improved sentiment – as evidenced in surveys and financial markets – will translate into a faster revival of activity and trade in the short term. Key downside risks include an increase in trade protectionism; a disorderly tightening of global financial conditions, which could affect vulnerable emerging market economies in particular; possible disruptions associated with China’s reform and liberalisation process; and the potential for volatility derived from political and geopolitical uncertainties, including those related to the negotiations on the future relations between the United Kingdom and the European Union. Finally, there is considerable uncertainty about the outlook for fiscal policy in the United States.


Global price developments

Global consumer price inflation remains relatively subdued. After falling during the early part of this year as the contribution of energy prices faded, annual consumer price inflation in the OECD area rose slightly in July to 2.0% (see Chart 3). Excluding food and energy, OECD annual inflation was stable at 1.8% in July.

Chart 3

OECD consumer price inflation

(year-on-year percentage changes; percentage point contributions)

-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2011 2012 2013 2014 2015 2016 2017 energy contribution food contribution excluding food and energy contribution excluding food and energy all items

Source: OECD.
Note: The latest observation is for July 2017.

Oil prices have risen in recent weeks. After falling during the early weeks of the summer, Brent crude oil prices have since recovered to around USD 52 per barrel. This increase reflected expectations of a moderately faster rebalancing of the oil market. US crude oil inventories fell by more than the market had expected, while oil demand was somewhat stronger in the second quarter of 2017. At the same time, supply constraints bolstered prices amid a slowdown in the growth rate of the US oil rig count and expectations that Saudi Arabia may curb exports of crude oil. So far, Brent crude oil prices or futures quotations have not been affected by tropical storm Harvey, which hit the US Gulf of Mexico.

Looking ahead, after a slight moderation in the near term, global inflation is expected to rise slowly. The oil futures curve indicates a modest increase in oil prices over the projection horizon, with energy prices providing a small positive contribution to inflation. At the same time, slowly diminishing spare capacity at the global level should support underlying inflation.


Financial developments

Euro area sovereign bond yields have remained broadly unchanged since the Governing Council’s monetary policy meeting on 8 June. Corporate bond spreads vis-à-vis the risk-free rate have declined marginally and remain below the levels observed in early March 2016 when the corporate sector purchase programme (CSPP) was announced. The equity prices of euro area non-financial corporations (NFCs) have fallen, mainly owing to an increase in perceived geopolitical risks, but they continue to be supported by robust earnings expectations. In foreign exchange markets, the euro has appreciated markedly.

Long-term euro area government bond yields have remained broadly unchanged overall since early June. During the period under review (from 8 June to 6 September 2017) the euro area ten-year overnight index swap (OIS) rate increased by 3 basis points, to 0.58%, while the GDP-weighted euro area ten-year sovereign bond yield increased by 1 basis point to 0.99% (see Chart 4). In the United States, long-term government bond yields declined by 8 basis points, to 2.11%. Developments in euro area long-term interest rates since early June have been muted overall, masking one particular episode of volatility when market participants somewhat abruptly revised their expectations regarding the future path of monetary policy and yields consequently increased. However, this increase unwound towards the end of the review period, partly on account of geopolitical tensions and less positive macroeconomic news both in the euro area and abroad.

Chart 4

Ten-year sovereign bond yields in the euro area, the United States and the United Kingdom

(percentages per annum)

0.0 0.5 1.0 1.5 2.0 2.5 3.0 01/15 04/15 07/15 10/15 01/16 04/16 07/16 10/16 01/17 04/17 07/17 euro area United States United Kingdom

Sources: Bloomberg and ECB.
Notes: For the euro area, the GDP-weighted average of ten-year sovereign bond yields is reported. The vertical grey line denotes the start of the review period on 8 June 2017. The latest observation is for 6 September 2017.

Sovereign bond spreads vis-à-vis risk-free OIS rates declined in a number of countries against the background of an improved euro area macroeconomic outlook. The declines ranged from 1 basis point in France to 19 basis points in Italy and 20 basis points in Portugal (see Chart 5). They were initially precipitated following the results of the French presidential election in April. Thereafter they reflected primarily an improvement in the euro area macroeconomic environment.

Chart 5

Euro area sovereign bond spreads vis-à-vis the OIS rate

(percentages per annum)