2015 was a year of recovery for the euro area economy. Inflation, however, remained on a downward path. Against this backdrop, a key theme for the euro area in 2015 was strengthening confidence. Confidence among consumers to boost spending. Confidence among firms to resume hiring and investing. And confidence among banks to increase lending. This was essential to nurture the recovery and underpin the return of inflation towards our objective of below, but close to, 2%.
As the year progressed, we did indeed see confidence firming. Domestic demand replaced external demand as the motor of growth on the back of rising consumer confidence. Credit dynamics began recovering for the euro area as a whole. Employment continued to pick up. And fears of deflation, which had stalked the euro area in early 2015, were dispelled entirely.
As we describe in this year’s Annual Report, the ECB contributed to that improving environment in two main ways.
The first and most important was through our monetary policy decisions. We took action decisively throughout the year to ward off threats to price stability and ensure the anchoring of inflation expectations. That began in January, with our decision to expand our asset purchase programme (APP). It continued with the various adjustments to the programme throughout the year, such as the expansion of the list of issuers whose securities are eligible for purchase. And it concluded with our decisions in December to cut our deposit facility rate further into negative territory and to recalibrate our asset purchases.
These measures proved effective. Financing conditions eased considerably, with bank lending rates falling by around 80 basis points in the euro area from mid-2014 onwards – a pass-through equivalent to a one-off rate cut of 100 basis points in normal times. Growth and inflation benefited too. According to Eurosystem staff assessments, without the APP – including the December package – inflation would have been negative in 2015, more than half of a percentage point lower in 2016, and around half of a percentage point lower in 2017. The APP will raise euro area GDP by around 1.5 percentage points in the period 2015-18.
We recalibrated our policy at the end of the year due to new headwinds from the global economy, which tilted the inflation outlook to the downside. Those headwinds intensified in early 2016, requiring a further expansion of our policy stance. In March 2016 the Governing Council decided to expand the APP in both size and composition (including for the first time corporate bonds), to cut the deposit facility rate further, to introduce a new series of targeted longer-term refinancing operations with powerful incentives for banks to lend, and to strengthen its forward guidance. These decisions reaffirmed that, even when faced with global disinflationary forces, the ECB does not surrender to excessively low inflation.
The ECB’s second contribution to confidence in 2015 was to address threats to the integrity of the euro area. These mainly concerned events in Greece in the first half of the year. Uncertainty about the commitment of the new government to its macroeconomic adjustment programme led to both banks and the government losing market access, and to depositors stepping up withdrawals of their money from banks. The Eurosystem provided a lifeline to the Greek banking system through its emergency liquidity assistance (ELA).
The ECB acted in full independence according to its rules. That meant, on the one hand, ensuring that we did not provide any monetary financing to the Greek government and that we only lent to banks which were solvent and had sufficient collateral, and on the other, ensuring that decisions with far-reaching implications for the euro area were taken by the legitimate political authorities. The approach we followed was fully within our mandate: it respected the commitment to the single currency contained in the Treaty, but we implemented that commitment within the limits of our Statute.
Although tail risks were finally averted thanks to the agreement between Greece and the other euro area countries on a third programme, this episode highlighted the fragility of the euro area and reaffirmed the need to complete our Monetary Union. To that end, as one of the so-called “Five Presidents”, in June 2015 I contributed to a report making concrete suggestions for further reform of the euro area’s institutional architecture. If we are to achieve a more robust union – and to avoid overburdening the central bank – those suggestions must ultimately be turned into actions.
Finally, in 2015 the ECB also strengthened confidence in its own decision-making processes by enhancing its transparency and governance. In January we began publishing the accounts of our monetary policy meetings, which has given the outside world a clearer insight into our deliberations. We also started publishing ELA decisions and the amounts concerned, data on TARGET2 balances, and the calendars of the Executive Board members. In a time of unconventional monetary policy, these steps forward in transparency are essential to ensure our full accountability to the public.
Our governance was improved too through a project aimed at optimising how the ECB functions as we expand into new tasks and confront new challenges. In 2015 we began implementing several of its recommendations, notably appointing for the first time a Chief Services Officer to support the internal organisation of the bank.
2016 will be a no less challenging year for the ECB. We face uncertainty about the outlook for the global economy. We face continued disinflationary forces. And we face questions about the direction of Europe and its resilience to new shocks. In that environment, our commitment to our mandate will continue to be an anchor of confidence for the people of Europe.
Frankfurt am Main, April 2016
Mario Draghi President
The euro area economy, the ECB’s monetary policy and the European financial sector in 2015
The euro area economy: the low inflation, low interest rate environment
The global macroeconomic environment
The euro area economy was affected in particular by three key features of the international environment in 2015: a growing divergence in economic activity between advanced and emerging market economies; historically weak global trade developments; and low global inflationary pressures on the back of further declining energy prices and still abundant spare capacity.
Global economic growth remained modest
The world economy continued along its gradual recovery path in 2015, although global economic growth moderated slightly from the previous year. The marginal acceleration in economic activity in advanced economies was more than offset by the slowdown in emerging economies, with considerable heterogeneity across countries and regions. Following strong recessions in some emerging economies in the first half of the year, global GDP growth remained modest by historical standards (see Chart 1).
Economic activity in advanced economies remained resilient throughout the year against the backdrop of still accommodative financing conditions, improving labour markets, low oil prices and diminishing headwinds from private sector deleveraging and fiscal consolidation. By contrast, the pace of economic growth slowed markedly in emerging market economies in the light of heightened uncertainty, structural impediments (e.g. related to infrastructure bottlenecks, poor business environments and a lack of competition in labour and product markets) and tightening external financing conditions. In particular, lower commodity prices led to a sharp slowdown in commodity-exporting economies, while growth remained more resilient in commodity-importing countries. The decline in commodity prices, however, had an overall positive effect on global demand, as oil-importing countries tend to have a higher propensity to spend than oil-exporting countries, but in some cases the positive impact on consumption was weaker than expected.
Main developments in selected economies
(annual percentage changes; quarterly data; monthly data)
Sources: Eurostat and national data.
Notes: GDP figures are seasonally adjusted. HICP for the euro area and for the United Kingdom; CPI for the United States, China and Japan.
Global financing conditions remained generally accommodative. The Federal Reserve System deferred the start of its monetary policy normalisation until the end of 2015, while both the Bank of Japan and the ECB continued to follow expansionary monetary policies. The Bank of England left its monetary policy unchanged. Financial market volatility and risk aversion remained relatively low for most of the year. In the third quarter of the year, however, a sharp correction in equity prices in Chinese stock markets led to a marked increase in volatility. While the spillover effects to the real economy were limited, the prospect of a growing divergence in the monetary policy stance of major advanced economies and market concerns about the resilience of economic growth in emerging economies led to considerable exchange rate depreciations and capital outflows in a number of emerging market economies, particularly those with significant domestic and external imbalances (see also Box 1).
Historically weak world trade developments
Following three years of weak trade growth, the growth rate of global imports of goods and services declined even further in the first half of the year, before gradually recovering towards the year-end from very low levels. Overall, the volume of world imports grew by only 1.7% year on year in 2015, compared with 3.5% in 2014. As in the case of GDP growth developments, emerging market economies were the main driver behind the global trade weakness, although some advanced economies temporarily experienced extremely weak trade growth as well.
Global import growth has been below its long-term average since the second half of 2011. Although this weakness is due in part to the subdued global recovery and is thus to some extent a cyclical phenomenon, the elasticity of world trade – i.e. the responsiveness of global import growth to GDP growth – has also been extraordinarily weak in the past four years. While trade increased at almost twice the rate of global GDP in the 25 years prior to 2007, its growth rate has fallen below that of GDP in recent years.
Possible reasons for the persistent weakness in global trade are manifold. On the one hand, cyclical factors include not only the generally sluggish recovery of global economic activity, but also the changed demand composition of global GDP, as import-intensive demand components (such as investment) have been particularly weak. On the other hand, structural factors may also play a significant role, including shifts in activity towards sectors (such as services) and regions (emerging market economies, in particular China) with lower underlying trade elasticities and changes in the participation in global value chains.
Low energy prices weighed on global inflation
The sharp fall in commodity prices – particularly energy prices – in the second half of 2014 contributed significantly to a decrease in global headline inflation in 2015 (see Chart 2). Annual inflation in the OECD area declined to 0.6% (down from 1.7% in 2014), while core annual OECD inflation (excluding food and energy) decreased only marginally, from 1.8% in 2014 to 1.7% in 2015 (see Chart 1).
Sources: Bloomberg and Hamburg Institute of International Economics.
While remaining low overall, oil prices showed considerable volatility throughout 2015. This followed a continuous decline from around USD 112 per barrel in June 2014 to USD 46 in mid-January 2015. After a temporary uptick until May 2015, oil prices declined in the second half of the year, continuing to reflect an oversupplied global oil market. The OPEC members maintained their production at near-record rates, although non-OPEC production growth was reduced somewhat in the second half of the year. In particular, lower prices and reduced investment triggered a slowing in the still resilient US shale oil production, leading to some moderation in the supply overhang. Crude oil demand picked up during 2015 on the back of lower prices, but remained too weak to keep pace with oil supply.
Non-oil commodity prices continued to decline on the back of both supply and demand factors. Lower global demand – particularly from China, which is the main source of demand for a number of metal commodities – added to the downward pressure on non-oil commodity prices. Lower food prices mainly reflected increased supply. Overall, in US dollar terms, food prices decreased by 18%, while the metal price index dropped by 17% in 2015.
Moreover, slowly closing output gaps in advanced economies and widening ones in several emerging market economies resulted in abundant spare capacity at the global level, which put further downward pressure on global inflation. At the individual country level, inflation was also strongly influenced by exchange rate movements. While the appreciation of the US dollar and the pound sterling at the beginning of the year led to additional downward pressure on inflation in the respective countries, some emerging market economies, such as Russia, Brazil and Turkey, faced upward price pressures stemming from a considerable depreciation of their currencies.
Heterogeneous growth developments in major economies
In the United States, economic activity remained resilient, with real GDP growth at 2.4% on average in 2015, unchanged from the previous year. After some weakness at the beginning of the year owing to temporary factors such as bad weather conditions and port traffic disruptions, GDP growth in the second and third quarters was fairly robust and mainly driven by final domestic demand, while net exports contributed negatively. Economic activity then decelerated again in the fourth quarter. Private consumption expenditure remained buoyant against the background of still accommodative financing conditions, lower oil prices, strengthened household balance sheets and improved consumer confidence. The underlying labour market momentum also remained robust, with a further decrease in the unemployment rate to 5.0% at the end of the year. In the light of the sharp decline in energy prices and the appreciation of the US dollar since the second half of 2014, inflation remained extremely low during the whole of 2015. Annual CPI inflation stood at 0.1% on average, down from 1.6% in 2014, while core CPI inflation (excluding food and energy) remained broadly unchanged at 1.8%.
Monetary policy stayed highly accommodative for most of 2015. Interest rate projections by the Federal Open Market Committee (FOMC) and federal funds futures moved down over time, as expectations regarding a rise in monetary policy interest rates shifted further into the future. In December 2015 the FOMC decided to raise the federal funds target range to 0.25-0.50%, which was its first rate hike in more than nine years. The fiscal stance was broadly neutral in the fiscal year 2015, with the fiscal deficit decreasing slightly to 2.5% of GDP, which was the lowest ratio since 2007.
In Japan, real GDP growth was relatively volatile during the year. Following the strong increase at the start of the year, economic activity temporarily weakened in the second quarter before returning to positive, albeit subdued, growth in the second half of the year. The recovery occurred against the background of a rebound in private consumption and exports. On average, real GDP expanded by 0.7% in 2015, which was a slight acceleration from 2014, when Japan passed through a strong recession owing to a hike in VAT rates. The fading base effects of this tax increase also led to a slowdown in inflation to 0.8% on average (down from 2.7% in 2014). Thus, despite the continuing quantitative and qualitative monetary easing programme implemented by the Bank of Japan, inflation is still well below its target of 2%, although core inflation showed some signs of acceleration towards the end of the year.
In the United Kingdom, economic activity slowed moderately in 2015. Annual GDP growth decelerated to 2.2% in 2015 from almost 3% in 2014, according to preliminary estimates. In particular, housing investment growth decelerated from the very fast pace of growth recorded in the previous year. Low inflation contributed to the increase in the real disposable income of households, thereby supporting private consumption and GDP growth. Compared with the previous year, the labour market continued to strengthen and the unemployment rate declined to around 5% by the end of 2015. Further progress was made with fiscal consolidation, and the general government deficit is estimated to have fallen to around 4½% of GDP in 2015. Inflation declined compared with one year before, hovering around the level of 0% throughout the year, on the back of low energy and food prices as well as the appreciation of the pound sterling. During 2015 the Bank of England’s Monetary Policy Committee maintained an accommodative monetary policy stance, keeping the policy rate at 0.5% and the size of the asset purchase programme at GBP 375 billion.
In China, the gradual slowdown of the economy continued against the backdrop of slower investment growth and weaker exports. Annual GDP growth decreased to 6.8% in 2015 from 7.3% in the previous year. Over the summer Chinese stock markets corrected sharply after posting very strong gains in the preceding months, raising concerns about financial stability and economic growth prospects in China and other emerging economies. The macroeconomic and financial stability impact of the stock market correction was, however, fairly limited. Faced with declining CPI inflation (down from 2.0% in 2014 to 1.5% in 2015) and in order to contribute to a stabilisation of growth, the People’s Bank of China continued the policy loosening that it had started in November 2014, with several additional cuts of benchmark and reserve requirement rates during 2015. Additionally, further reforms were introduced to strengthen the role played by market forces in the determination of the exchange rate, which led to a depreciation of the renminbi – and other emerging market currencies – against the US dollar and renewed stock market volatility in the weeks following the decision. Regarding fiscal policy, public infrastructure spending was raised in order to support total investment.
The euro continued to weaken
In the course of 2015 the exchange rate of the euro weakened in nominal effective terms. Developments in the euro exchange rate continued to reflect to a large extent the different cyclical positions and monetary policy stances across major economies. These developments were characterised by four distinct phases. In the first quarter of 2015 the euro depreciated markedly ahead of the announcement of the expanded asset purchase programme by the ECB. The euro then stabilised in the second quarter, notwithstanding occasional bouts of volatility related to developments in the negotiations between Greece and its international creditors, as well as to changes in market expectations about the timing of a possible increase in the Federal Reserve’s policy rates in the United States. Over the summer the euro appreciated markedly in an environment of heightened risk aversion globally and uncertainties about developments in China and emerging economies more generally. In the fourth quarter the euro depreciated again overall on the back of renewed expectations of a growing divergence in monetary policy stances on either side of the Atlantic.
Euro exchange rate
Note: Nominal effective exchange rate against 38 major trading partners.
The nominal effective exchange rate of the euro (as measured against 38 major trading partners) declined by more than 3% in annual terms (see Chart 3). Bilaterally, the euro weakened strongly against the US dollar (-11.0%). In line with this, the euro continued to weaken against currencies that use the US dollar as an anchor, such as the Chinese renminbi (-6.5%). The euro also depreciated against the pound sterling (-5.9%) and the Japanese yen (-10.3%). By contrast, the euro appreciated markedly against the Brazilian real (+29.2%) and the South African rand (+18.9%).
Turning to those European currencies that have close links to the euro, the Danish krone is currently the only currency in the European exchange rate mechanism II (ERM II), after Lithuania joined the euro area on 1 January 2015. The Danish krone traded close to its central rate within ERM II, while Danmarks Nationalbank lowered its policy rates on four occasions in January and February 2015. Following the announcement of the Swiss National Bank on 15 January 2015 that it would discontinue its minimum exchange rate target of 1.20 Swiss francs per euro, the euro depreciated sharply against the Swiss franc, to trade somewhat above parity thereafter. The Bulgarian lev remained fixed to the euro, while the euro weakened modestly against some of the currencies of EU Member States with floating exchange rate regimes, including the Czech koruna (-2.6%), the Polish zloty (-0.2%), the Swedish krona (-2.2%) and the Croatian kuna (-0.3%).
Box 1 Financial stress in emerging market economies
Concerns about the economic growth prospects of China and emerging market economies more generally as well as rising expectations of monetary policy normalisation in the United States led to a period of heightened volatility in emerging economies’ financial markets in 2015. Several countries were subject to marked capital outflows from domestic bond and equity markets, coupled with a rise in corporate and sovereign bond spreads and substantial depreciation pressures on their domestic currency. In an attempt to lean against these headwinds, various central banks engaged in large-scale interventions in foreign exchange markets by selling foreign currency reserves. Tensions culminated in late August 2015, when a sharp correction of Chinese stock markets led to a marked increase in global risk aversion with significant repercussions on global, including euro area, financial markets.
Financial stress in major emerging market economies peaked in the third quarter of 2015, at a level which was very high also from a longer-term perspective. Chart A shows an aggregate indicator of financial stress in emerging market economies that combines information on portfolio flows, exchange rate developments, movements in domestic bond spreads and changes in foreign exchange reserve holdings. This indicator peaked in September 2015, reaching the second-highest levels seen over the past ten years and also surpassing the elevated levels reached during the “taper tantrum” episode in mid-2013. Only the immediate aftershock of the global financial crisis in late 2008 gave rise to higher levels of stress. In terms of the individual components of the aggregate indicator, the high levels of stress over 2015 were mostly driven by exchange rate developments and, to a lesser extent, by declines in foreign official reserves. After the fall in the Chinese stock market in late August 2015, emerging market economies also registered strong equity outflows, which contributed to the peak in financial stress in September 2015.
Financial stress in major emerging market economies
Sources: Haver, Institute of International Finance and ECB calculations.
Notes: The indicator of financial stress in emerging market economies combines information from different financial market time series: (1) portfolio flows into bond and equity markets (Institute of International Finance); (2) bilateral nominal exchange rate developments against the US dollar (Federal Reserve Board); (3) changes in domestic bond market spreads vis-à-vis US bond yields (JP Morgan’s Emerging Market Bond Index); and (4) changes in foreign exchange reserve holdings (IMF International Financial Statistics). The indicator shown corresponds to a three-month moving average of the first principal component, which explains around 50% of the total variation of the original dataset. Positive/negative values of the indicator indicate stress levels above/below the long-run average. The country sample comprises Brazil, China, India, Indonesia, Mexico, South Africa, South Korea, Thailand and Turkey. Data are monthly and cover the period from January 2005. The latest observation is for December 2015.
While rising expectations of US monetary policy normalisation contributed to the heightened volatility in financial markets in 2015, they were probably not the main trigger. US rate hike expectations brought about a broad-based US dollar appreciation in 2015 and increased volatility in foreign exchange markets. At the same time, the December 2015 rate increase was well anticipated by the markets and had been largely priced in since the beginning of the year. Furthermore, in contrast to the taper tantrum episode, ten-year US Treasury yields did not show a clear upward trend in 2015 and the term premium remained very compressed.
The acute financial volatility in emerging market economies during 2015 stemmed to a greater extent from concerns about the implications of slowing growth in China and the commodity price slump. For example, following the correction in the Chinese stock market in August 2015, some net commodity-exporting emerging market economies experienced sharp depreciations of their currencies. The currencies of the economies with strong trade links to China also reacted strongly, including those of Chile, Indonesia, Malaysia and Thailand.
At the same time, existing vulnerabilities and concerns about lower growth prospects also contributed to financial market stress. Most emerging market economies have experienced a moderation in growth in recent years, driven by both cyclical factors and structural impediments, and are facing lower growth prospects in the years ahead. Moreover, some of the economies which were already deemed fragile by financial markets during the 2013 taper tantrum have remained so. Brazil, Indonesia and South Africa continued to run twin deficits (fiscal and current account), as they had at the start of 2013, with Brazil and South Africa also suffering from high inflation and weakening growth. Turkey also continued to exhibit significant external imbalances, along with high inflation and credit growth. The commodity price slump has negatively affected net commodity exporters, including Russia and Brazil. In Russia, the ongoing slowdown has been exacerbated by economic sanctions and low oil prices, which pushed the economy into a sharp recession. By contrast, India has managed to correct some of its vulnerabilities compared with 2013, lowering both the inflation rate and the current account deficit, as the authorities introduced a range of stabilisation and growth-enhancing measures.
Changes in the credit-to-GDP ratio and debt service ratio
(Q1 2010 - Q2 2015; percentage points of GDP; percentage points)
Sources: Bank for International Settlements and ECB calculations.
Notes: Credit refers to total credit to the non-financial sector provided by domestic banks, all other sectors of the economy and non-residents; in terms of financial instruments, it covers “core debt”, defined as loans, debt securities and currency and deposits. The debt service ratio reflects the share of income used to service debt in the non-financial private sector. A list of country abbreviations can be found at the end of this report.
Rapid credit growth has also made many emerging market economies susceptible to tightening global financing conditions. Loose global financing conditions have contributed to fast credit expansion in many of these countries over recent years (see Chart B). In China, where fast-rising credit has supported strong investment, credit to the non-financial private sector reached around 200% of GDP in 2015. Despite low interest rates, rising debt levels have pushed up debt service ratios for households and firms in many emerging markets, signalling increased risks to financial stability, particularly if the tightening of global financing conditions were to raise interest rates further. Moreover, in recent years several emerging market economies have significantly increased external financing in US dollars, which makes them vulnerable to a further US dollar appreciation.
Overall, the financial stress in 2015 highlighted existing vulnerabilities in some emerging market economies and the need to address them, especially in the context of the likely tightening of global financing conditions and the lower growth prospects of these countries.
Euro area financial dynamics in 2015 were shaped to a large extent by the monetary policy decisions of the ECB, and in particular the asset purchase programme (APP). As a consequence, money market rates, government bond yields and the cost of external financing for non-financial corporations all continued their declines to new historical lows. Households also saw a further improvement in their financial conditions.
Euro area money market rates declined amid rising levels of excess liquidity
Money market rates continued to decline in 2015, initially reflecting the continued pass-through of the negative deposit facility rate, first introduced in June 2014. The initial strategies by investors to avoid negative interest rates through a search for yield at somewhat longer maturities, the purchase of high-quality securities and, to a lesser extent, the taking-on of more credit risk were progressively exhausted as pricing adjusted. In addition, market frictions associated with the transition to negative rates faded gradually.
Money market rates and excess liquidity
(EUR billions; percentages per annum; daily data)
Sources: ECB and Bloomberg.
Note: The latest observations are for 11 January 2016.
Liquidity injections by means of non-standard monetary policy measures put additional downward pressure on money market rates. In particular, the APP and the targeted longer-term refinancing operations (TLTROs) were the main drivers of rising excess liquidity. With excess liquidity rising above €650 billion at the end of the year, rates turned increasingly negative (see Chart 4) and activity declined in certain segments of the euro area money market.
In the period preceding the December 2015 Governing Council meeting, money market rates decreased even further, reflecting market expectations of additional monetary easing. On 3 December 2015 the Governing Council decided to cut the deposit facility rate to -30 basis points and extended the APP at least until March 2017. As a result, money market yield curves gradually shifted further downwards.
Overall, despite some initial concerns, the transition of a broad set of reference rates to negative levels went smoothly, including the transmission to longer maturities such as the six-month EURIBOR. The three-month EURIBOR and six-month EURIBOR turned negative in April and November respectively, and stood at -13 basis points and -4 basis points respectively at end-2015.
Government bond yields reached historical lows
The euro area government bond market was strongly influenced by the public sector purchase programme (PSPP) (see Chart 5). First, as a result of the announcement and implementation of the PSPP, long-term yields on AAA-rated debt continued the decline that started in 2014 to reach new historical lows in the spring. Thereafter, yields increased up to mid-2015 owing to positive surprises regarding the euro area’s economic outlook, technical market factors and a learning process in which the market adapted to the implementation of the PSPP. In the second half of 2015 yields resumed their decline as continued downside risks to the inflation outlook prompted further monetary policy accommodation by the ECB, including an extension of the APP. Overall, the average euro area ten-year yield over the year reached a historical low of 0.6%. This is notably lower than the averages recorded in previous years and is also significantly lower than the average of 2.1% recorded in the United States. It was, however, higher than the 0.4% observed in Japan.
Developments in intra-euro area government bond spreads were relatively muted year on year, but showed some heterogeneity across countries. At the same time, spreads remained at levels comparable to those before the start of the sovereign debt crisis.
Long-term government bond yields
(percentages per annum; daily data)