Based on its regular economic and monetary analyses, the Governing Council decided at its meeting on 8 July 2010 to leave the key ECB interest rates unchanged. The current rates remain appropriate. Taking into account all the new information which has become available since its meeting on 10 June 2010, the Governing Council continues to expect price developments to remain moderate over the policy-relevant medium-term horizon, benefiting from low domestic price pressures. The latest information has also confirmed that the economic recovery in the euro area continued in the first half of 2010. Looking ahead, the Governing Council expects the euro area economy to grow at a moderate and still uneven pace, in an environment of high uncertainty. The monetary analysis confirms that inflationary pressures over the medium term remain contained, as suggested by weak money and credit growth. Overall, the Governing Council expects price stability to be maintained over the medium term, thereby supporting the purchasing power of euro area households. Inflation expectations remain firmly anchored in line with the aim of keeping inflation rates below, but close to, 2% over the medium term. The firm anchoring of inflation expectations remains of the essence.
Monetary policy will do all that is needed to maintain price stability in the euro area over the medium term. This is the necessary and central contribution that monetary policy makes to fostering sustainable economic growth, job creation and financial stability. All the non-standard measures taken during the period of acute financial market tensions, referred to as “enhanced credit support” and the Securities Markets Programme, are fully consistent with the Governing Council’s mandate and, by construction, temporary in nature. The Governing Council remains firmly committed to price stability over the medium to longer term. The monetary policy stance and the overall provision of liquidity will be adjusted as appropriate. Accordingly, the Governing Council will continue to monitor all developments over the period ahead very closely.
Turning to the economic analysis, after a period of sharp decline, euro area economic activity has been expanding since mid-2009. Euro area real GDP increased, on a quarterly basis, by 0.2% in the first quarter of 2010, according to Eurostat’s second estimate. The latest economic data and survey-based indicators suggest that a strengthening in economic activity took place during the spring. The Governing Council expects real GDP to grow at a moderate and still uneven pace over time and across economies and sectors of the euro area. The ongoing recovery at the global level and its impact on the demand for euro area exports, together with the accommodative monetary policy stance and the measures adopted to restore the functioning of the financial system, should provide support to the euro area economy. However, the recovery in activity is expected to be dampened by the process of balance sheet adjustment in various sectors and labour market prospects.
According to the Governing Council’s assessment, the risks to the economic outlook are broadly balanced, in an environment of high uncertainty. On the upside, the global economy and foreign trade may recover more strongly than projected, thereby further supporting euro area exports. On the downside, concerns remain relating to renewed tensions in financial markets, with possible further adverse effects on financing conditions and confidence. In addition, a stronger or more protracted than previously expected negative feedback loop between the real economy and the financial sector, renewed increases in oil and other commodity prices, and protectionist pressures, as well as the possibility of a disorderly correction of global imbalances, may weigh on the downside.
With regard to price developments, euro area annual HICP inflation was 1.4% in June, according to Eurostat’s flash estimate, after 1.6% in May. In the next few months, annual HICP inflation rates are expected to display some further volatility, with a tendency towards somewhat higher rates later in the year. Looking ahead, in 2011 inflation rates should overall remain moderate, benefiting from low domestic price pressures. Inflation expectations over the medium to longer term continue to be firmly anchored in line with the Governing Council’s aim of keeping inflation rates below, but close to, 2% over the medium term.
Risks to the outlook for price developments are broadly balanced. Upside risks over the medium term relate, in particular, to the evolution of commodity prices. Furthermore, increases in indirect taxation and administered prices may be greater than currently expected, owing to the need for fiscal consolidation in the coming years. At the same time, risks to domestic price and cost developments are contained. Overall, the Governing Council will monitor closely the future evolution of all available price indicators.
Turning to the monetary analysis, the annual growth rate of M3 was unchanged at -0.2% in May 2010. The annual growth rate of loans to the private sector increased slightly further but, at 0.2%, remained weak. Together, these data continue to support the assessment that the underlying pace of monetary expansion is moderate and that inflationary pressures over the medium term are contained. Shorter-term developments in M3 and some of its components and counterparts have remained volatile and, given the continued tensions in some financial market segments, this volatility may well persist.
The previously strong impact of the interest rate constellation on monetary dynamics appears to be gradually waning. This implies that actual M3 growth is less affected than before by the downward impact of the steep yield curve and the associated allocation of funds into longer-term deposits and securities outside M3. Moreover, the impact that the narrow spreads between the interest rates paid on different M3 instruments have on shifts within M3 towards M1 should be diminishing. However, at 10.3%, annual M1 growth is still very strong.
The still weak annual growth rate of bank loans to the private sector continues to conceal countervailing developments, with positive growth in loans to households and negative growth in loans to non-financial corporations. While the monthly flow in bank loans to non-financial corporations was positive in May, in the light of the volatility observed in recent months it is too early to judge whether this signals a turning-point. A lagged response of loans to non-financial corporations to developments in economic activity is a normal feature of the business cycle.
The data up to May confirm that the size of banks’ overall balance sheets has increased since the turn of the year. The challenge remains for banks to expand the availability of credit to the non-financial sector when demand picks up. Where necessary, to address this challenge, banks should retain earnings, turn to the market to strengthen further their capital bases or take full advantage of government support measures for recapitalisation. In this respect, the Governing Council welcomes the decision announced by the European Council to publish, with the consent of the banks involved, the individual results of the stress test exercise for banks in the European Union carried out by the Committee of European Banking Supervisors (CEBS) in cooperation with the ECB. Appropriate action will have to be taken where needed. Sound balance sheets, effective risk management and transparent, robust business models are key to strengthening banks’ resilience to shocks and to ensuring adequate access to finance, thereby laying the foundations for sustainable growth, job creation and financial stability.
To sum up, the current key ECB interest rates remain appropriate. Taking into account all the new information which has become available since its meeting on 10 June 2010, the Governing Council continues to expect price developments to remain moderate over the policy-relevant medium-term horizon, benefiting from low domestic price pressures. The latest information has also confirmed that the economic recovery in the euro area continued in the first half of 2010. Looking ahead, the Governing Council expects the euro area economy to grow at a moderate and still uneven pace, in an environment of high uncertainty. A cross-check of the outcome of the economic analysis with that of the monetary analysis confirms that inflationary pressures over the medium term remain contained, as suggested by weak money and credit growth. Overall, the Governing Council expects price stability to be maintained over the medium term, thereby supporting the purchasing power of euro area households. Inflation expectations remain firmly anchored in line with the aim of keeping inflation rates below, but close to, 2% over the medium term. The firm anchoring of inflation expectations remains of the essence.
As regards fiscal policies, the focus clearly needs to be on ensuring the sustainability of public finances. In the current environment, all euro area countries must, as a minimum, comply with their fiscal consolidation plans as foreseen under the respective excessive deficit procedures. More ambitious targets, as already adopted by a number of countries, may become necessary where current plans fall short of meeting the main objective of halting and reversing the increase in the government debt ratio. Moreover, all countries must specify credible adjustment measures that are sufficient to attain their budgetary targets for 2010, 2011 and beyond, and must live up to their commitment to take additional measures, where needed, over the coming years.
For the proper functioning of the euro area, and to strengthen the prospects for higher sustainable growth, the pursuit of far-reaching structural reforms is essential. This will also support the process of fiscal consolidation. Major reforms are particularly needed in those countries that have experienced competitiveness losses in the past or that are suffering from high fiscal and external deficits. Measures should ensure a wage bargaining process that allows wages to adjust flexibly to the unemployment situation and losses in competitiveness. Reforms to strengthen productivity growth would further support the adjustment process of these economies.
Regarding the proposals submitted by the Governing Council to the Task Force on Economic Governance established by the European Council under the chairmanship of President Van Rompuy, in the view of the Governing Council a quantum leap in terms of progress towards strengthening the institutional foundations of EMU is needed. It is essential that governance and enforcement structures in the economic policy framework of the euro area be strengthened. Reinforcing surveillance of national budgetary policies and ensuring rigorous compliance with the fiscal rules will be key. Furthermore, it is extremely important that close oversight of relative competitiveness developments be implemented and that a surveillance mechanism be established to address imbalances in the euro area countries. At the same time, it is important to establish an appropriate euro area crisis management framework that minimises moral hazard.
This issue of the Monthly Bulletin contains three articles. The first article examines euro area labour market adjustments in the context of the recent recession. The second article assesses the effectiveness of euro area fiscal policies. The third article discusses the impact of the financial crisis on economic activity in the central and eastern European countries.back to top