Economic and monetary developments

Overview

At its monetary policy meeting on 14 December 2017, the Governing Council concluded that an ample degree of monetary accommodation is still needed to secure a return of inflation towards levels that are below, but close to, 2%. The information that has become available since the previous monetary policy meeting in late October, including the new Eurosystem staff projections, indicates a strong pace of economic expansion and a significant improvement in the growth outlook. The Governing Council assessed that the strong cyclical momentum and the significant reduction of economic slack give grounds for greater confidence that inflation will converge towards its aim. At the same time, domestic price pressures remain muted overall and have yet to show convincing signs of a sustained upward trend. The Governing Council therefore concluded that an ample degree of monetary stimulus remains necessary for underlying inflation pressures to continue to build up and support headline inflation developments over the medium term. This continued monetary support is provided by the additional net asset purchases that the Governing Council decided on at the October monetary policy meeting, by the sizeable stock of acquired assets and the forthcoming reinvestments, and by the forward guidance on interest rates.

Economic and monetary assessment at the time of the Governing Council meeting of 14 December 2017

The Governing Council’s economic assessment reflected that the euro area economic expansion continues to be solid and broad-based across countries and sectors. Real GDP growth is supported by growth in private consumption and investment as well as exports benefiting from the broad-based global recovery. The latest survey results and incoming data confirm robust growth momentum. The global economy is also continuing to expand at a solid rate, and the recovery shows signs of synchronisation globally.

Financing conditions in the euro area have remained very favourable. Euro area sovereign bond yields have declined slightly since 7 September. Corporate bond spreads have also fallen, while equity prices of euro area non-financial corporations (NFCs) have increased. At the same time, valuations of corporate bonds and equities have continued to be supported by the robust economic outlook. In foreign exchange markets, the euro has remained broadly unchanged in recent months.

Looking ahead, the December 2017 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 2.4% in 2017, 2.3% in 2018, 1.9% in 2019 and 1.7% in 2020. Compared with the September 2017 ECB staff macroeconomic projections, the outlook for GDP growth has been revised upwards substantially. The ongoing economic expansion in the euro area is expected to continue to be supported by the ECB’s monetary policy measures. Furthermore, private expenditure and consumption growth are supported by lower deleveraging needs and improved labour market conditions. Improvements in corporate profitability and the very favourable financing conditions continue to promote the recovery in business investment, while euro area exporters are benefiting from the ongoing global economic expansion.

Euro area annual HICP inflation was 1.5% in November, up from 1.4% in October, according to Eurostat’s flash estimate. At the same time, measures of underlying inflation have moderated somewhat recently, in part owing to special factors. Looking ahead, on the basis of current futures prices for oil, annual rates of headline inflation are likely to moderate in the coming months, mainly reflecting base effects in energy prices, before increasing again. Underlying inflation is expected to rise gradually over the medium term, supported by the ECB’s monetary policy measures, the continuing economic expansion, the corresponding absorption of economic slack and rising wage growth.

This assessment is also broadly reflected in the December 2017 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.5% in 2017, 1.4% in 2018, 1.5% in 2019 and 1.7% in 2020. Compared with the September 2017 ECB staff macroeconomic projections, the outlook for headline HICP inflation has been revised up, mainly reflecting higher oil and food prices.

The latest staff projections also foresee the euro area budget deficit declining further over the projection horizon, mainly as a result of improving cyclical conditions and decreasing interest payments. The aggregate fiscal stance for the euro area is projected to be broadly neutral. The euro area government debt-to-GDP ratio is expected to continue to decline, albeit from a still high level.

Complementing the economic assessment, the monetary analysis showed that money growth remained robust in October and during the third quarter of 2017. Broad money continued to expand at 5% in October, in line with the steady pace witnessed since mid-2015. The recovery in loan growth to the private sector has also continued. The annual flow of total external financing to NFCs is estimated to have strengthened in the third quarter of 2017, reflecting improvements in both bank lending and debt securities issuance.


Monetary policy decisions

Based on the regular economic and monetary analyses, the Governing Council confirmed the need for an ample degree of monetary accommodation 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 continues to expect 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 its intention to continue to make net asset purchases under the asset purchase programme (APP), from January 2018 onwards at a monthly pace of €30 billion, until the end of September 2018, 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. Moreover, the Governing Council reconfirmed that if the outlook became less favourable, or if financial conditions became inconsistent with further progress towards a sustained adjustment in the path of inflation, it would stand ready to increase the APP in terms of size and/or duration. The Governing Council also reiterated that the Eurosystem will reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary.


External environment

The global economy is continuing to expand at a solid rate, with increasing signs of synchronisation. The outlook among advanced economies entails robust expansion, which slows down over the projection horizon as the upturn matures. Among emerging market economies, the outlook is supported by strengthening activity in commodity exporters. Global trade indicators point to a rebound in the third quarter. Global inflation is expected to rise slowly as spare capacity at the global level diminishes.

Global economic activity and trade

The sustained pace of expansion of the global economy has become more broad-based and extended into the second half of the year. The recovery shows signs of synchronisation globally, as the share of countries with growth in economic activity above the average of recent years has been increasing since the second half of 2016. Across advanced economies, US economic activity expanded at a solid pace in the third quarter, in spite of the impact of the recent hurricanes. Real GDP growth in Japan also remained robust, while activity in the United Kingdom was relatively muted, partly on account of the negative effect of the depreciation of the pound on real household income and consumption, which more than offset the gains in competitiveness and the positive impetus from the increasingly robust expansion in the euro area. Across emerging economies, activity has been supported by India and China, as well as by the recoveries in Brazil and Russia after their deep recessions, although some loss of dynamism is anticipated in the short term in the latter.

Survey-based indicators and sentiment surveys point to sustained global growth in the near term. The global composite output Purchasing Managers’ Index (PMI), excluding the euro area, remained at similar levels in the third quarter to those recorded in the previous two quarters, close to long-run averages, and pointing to a continued steady expansion in global activity (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 60 2011 2012 2013 2014 2015 2016 2017 global excluding euro area global excluding euro area – long-term average advanced economies excluding euro area emerging market economies

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

Monetary policies show some divergence, but overall global financial conditions remain supportive. Markets continue to expect a very gradual monetary tightening in the United States. The Federal Open Market Committee (FOMC) left policy rates unchanged at its September meeting, but decided to start reducing the Federal Reserve System’s balance sheet. In December, in line with market expectations, a rate hike took place. Expectations of tightening in the United Kingdom, confirmed by the rise in the official policy rate, continued to firm following the surge in inflation to above target levels and persistent upward price pressures following the recent depreciation of the pound. In Japan, the Bank of Japan maintained its accommodative stance. In China, in order to curb leverage in the financial system, the People’s Bank of China has allowed financial conditions to tighten since the beginning of the year, increasing its open-market interest rates and guiding interbank rates upwards. Other emerging market economies (EMEs), including India and some commodity exporters, lowered policy rates as inflationary pressures subsided and exchange rates firmed. Overall, financial market sentiment has remained strong in advanced economies, with gains in equity markets and a further decline in volatility. Among EMEs, interest rates have declined in various key economies, contributing to a modest easing in financial conditions, and capital inflows have risen strongly.

Looking ahead, economic activity is expected to remain broadly stable at the global level, but developments across countries and regions vary notably. The outlook among advanced economies is for a robust expansion, which slows down over the projection horizon as the recoveries – particularly in the United States and Japan – mature and output gaps gradually close, while growth in the United Kingdom is anticipated to remain muted. Among EMEs, the outlook is supported by the recovery in commodity exporters, particularly Brazil and Russia. In India and China, growth remains solid, but China is expected to transition to a lower growth trajectory in view of slowing potential growth. Overall, these trends broadly offset each other, leading to a stable global GDP growth outlook.

The growth potential has declined across most advanced and emerging economies in recent years and is expected to stabilise at below pre-crisis levels. In advanced economies, capital contributions have diminished as rates of investment have fallen in the wake of the financial crisis, driven by the ensuing weakened expectations of demand prospects together with tighter financial conditions and heightened uncertainty. Investment was also lower in emerging market economies, in particular in commodity-exporting countries. Waning support from demographics has added to the decline in growth potential in several countries.

In the United States, activity is expected to remain robust on the back of solid domestic demand. The recovery will continue on the back of solid growth in investment and consumption, as tight labour market conditions gradually feed into higher wage growth and favourable financial conditions boost wealth. Moreover, the strengthening of external demand and the recent depreciation of the US dollar also support the US outlook. The tax reform and the associated fiscal package are likely to provide some impetus from next year onwards. However, GDP growth is projected to decelerate gradually in the medium term, returning to its potential.

In the United Kingdom, real GDP growth is expected to remain relatively muted owing to high uncertainty. The recent slowdown in economic activity, led by private consumption as households began to feel the impact of rising inflation and shrinking real wage growth, is expected to extend over the coming quarters. Relatively subdued growth expectations reflect the ongoing impact of high uncertainty and the strong depreciation of the pound in the aftermath of the UK referendum on EU membership.

In Japan, economic expansion is expected to remain firm, supported by domestic and external factors. While waning fiscal support is likely to act as a drag on growth, economic activity is expected to be supported by firming foreign demand, private investment gains associated with high profits and increasing labour and capacity shortages, and favourable financing conditions. The planned VAT hike in October 2019 is, however, expected to have a negative impact on economic activity after its implementation.

In China, activity continues to expand at a robust pace, supported by resilient consumption and a still robust housing market. The near-term outlook is dominated by the authorities’ focus on stable growth, given the ongoing political transition, while the assumption over the medium term is that continued structural reforms will gradually be implemented, leading to an orderly slowdown.

Economic activity in central and eastern European countries is expected to accelerate in the near term, driven by a rebound in investment and strong private consumption. Domestic demand will continue to be the main driver of economic growth looking forward, on the back of improving labour markets and higher absorption of EU funds.

The large commodity-exporting countries are continuing their recovery following deep recessions. In Russia, leading indicators signal a softening of the recovery in the short term, but growth is expected to resume afterwards, supported by higher oil prices, a stronger rouble and declining inflation. Over the medium term, growth is expected to remain mild amid fiscal challenges weighing on the business environment and the lack of fixed investment and structural reforms undermining Russia’s supply capacity. In Brazil, although recurring political uncertainties are continuously weighing on business investment and consumer spending, loosening financial conditions alongside increasing monetary accommodation and improving terms of trade will support the economy over the medium term.

Global trade growth remained robust in the second quarter, and prospects remain positive in the near term. Global merchandise import growth momentum suggests continued robust global trade in the third quarter of the year (see Chart 2). The volume of merchandise imports increased by 1.6% in September (in three-month-on-three-month terms), mainly due to a sharp rebound in import growth in EMEs, particularly in Asia and Latin America. In advanced economies, by contrast, September data point to a negative reading for the United States and Japan, confirming the fall in imports (goods and services) in available national accounts releases. Leading indicators seem to confirm robust world trade dynamics, with PMI new export orders remaining at high levels at the start of the fourth quarter.

 

Chart 2

World trade in goods

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

44 46 48 50 52 54 56 58 60 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 2011 2012 2013 2014 2015 2016 2017 global merchandise imports (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 November 2017 (global PMI manufacturing), October 2017 (global PMI new export orders) and September 2017 (trade).

Looking further ahead, global trade is expected to continue expanding. The combination of strong trade indicators and surveys and the repeated surprises on the upside could suggest that there is more cyclical momentum in world trade than previously anticipated related to the cyclical upturn and the recovery in investment.

Overall, global growth is projected to remain broadly stable over the projection horizon. According to the December 2017 Eurosystem staff macroeconomic projections, world real GDP growth (excluding the euro area) is projected to increase from 3.7% in 2017 to 3.9% in 2018, before gradually returning to 3.7% in 2020. This development results from a gradual slowdown over the projection horizon for advanced economies, where the cycle is more mature, which is offset by increased dynamism in EMEs, particularly in Latin America. Growth in euro area foreign demand is forecast to expand by 5.5% in 2017, 4.4% in 2018, 3.8% in 2019 and 3.5% in 2020. Compared with the September 2017 projections, global GDP is only revised marginally upwards in 2017‑18. Growth in euro area foreign demand has been revised upwards over the whole projection horizon, reflecting data revisions and a more positive view on medium-term developments.

Risks to the outlook for global activity are on the upside in the short term, but remain skewed to the downside in the medium term. On the upside, there is a possibility that improved sentiment will translate into a faster-than-expected revival in activity. A larger than expected fiscal stimulus along the lines currently being discussed in the US Congress also presents a moderate upside risk to US and global growth. However, medium-term downside risks prevail, such as an increase in trade protectionism, a sudden tightening in global financial conditions (which could affect vulnerable EMEs in particular), disruptions associated with China’s reform and liberalisation process, and political and geopolitical uncertainties, including those related to the negotiations on the future relations between the United Kingdom and the European Union.


Global price developments

Global consumer price inflation declined slightly in October, as energy prices decelerated. After increasing during the previous few months, as the contribution of energy prices intensified, annual consumer price inflation in the OECD area declined in October, to 2.2% (see Chart 3). However, excluding food and energy, OECD annual inflation increased to 1.9%, after having remained stable at 1.8% for the previous five months.

 

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 October 2017.

Oil prices have continued to increase in recent weeks. Brent crude oil prices rose from USD 50 per barrel in mid-August to over USD 64 per barrel recently. Higher prices were supported by geopolitical tensions in the Middle East and recent developments in Venezuela, firming expectations of an extension of the OPEC/non-OPEC agreement on supply cuts beyond March 2018, confirmed by the actual extension on 30 November 2017 to the end of 2018, and robust oil demand. Oil futures suggest that oil prices will fall below current levels, to around USD 61 per barrel in 2018 and USD 58 per barrel in 2019. By contrast, non-energy commodity prices have fallen slightly in the last few weeks, although iron ore quotations increased. Box 1 analyses the drivers of metal prices in more detail, decomposing them into demand and supply effects.

Looking ahead, global inflation is expected to rise slowly. While the current oil futures curve anticipates a slight decline in oil prices over the projection horizon, pointing to a very limited contribution from energy prices to inflation, the slowly diminishing spare capacity at the global level is expected to support underlying inflation.


Financial developments

Euro area sovereign bond yields have declined slightly since the Governing Council’s monetary policy meeting on 7 September. Corporate bond spreads have also fallen, while equity prices of euro area non-financial corporations (NFCs) have increased as perceived geopolitical risks have waned. At the same time, valuations of corporate bonds and equities have continued to be supported by the robust economic outlook. In foreign exchange markets, the euro has remained broadly unchanged.

Long-term euro area government bond yields have declined slightly since early September. During the period under review (from 7 September to 13 December 2017), the ten-year sovereign bond yield in Germany increased by 2 basis points to 0.32% (see Chart 4). However, the GDP-weighted euro area ten-year sovereign bond yield decreased by 5 basis points to 0.88%, owing to idiosyncratic falls in the sovereign bond yields of some euro area countries. In the United States and the United Kingdom, long-term government bond yields increased by 30 basis points and 24 basis points, to 2.34% and 1.21% respectively. Developments in euro area long-term interest rates since early September have been muted overall and have not mirrored increases abroad, owing to market expectations for euro area monetary policy. In the United States, the rise was driven partly by the prospect of reforms to the federal tax code, while in the United Kingdom, a reassessment of the future path of monetary policy was a factor.

 

Chart 4

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

(percentages per annum)