2016 was in many ways a difficult year, but it was also marked by signs of progress. Though the year began shrouded in economic uncertainty, it ended with the economy on its firmest footing since the crisis.
Yet as economic uncertainty subsided, political uncertainty increased. We faced a series of geopolitical events that will shape our policy landscape for years to come. This year’s Annual Report describes how the ECB navigated these choppy waters.
2016 opened amid fears of a renewed global slowdown, reflected in pronounced financial market volatility. There was a danger that the return of inflation to our objective would be further delayed and – with inflation already very low – deflation risks were material. Just as in 2015, the Governing Council remained determined to use all the tools within its mandate to fulfil its objective.
So in March, we introduced a series of new measures to expand our monetary stimulus, including lowering our key policy rates further, increasing the asset purchase programme from €60 billion to €80 billion a month, purchasing corporate bonds for the first time, and launching new targeted longer-term refinancing operations.
As we describe in the Report, these measures proved very effective in easing financing conditions, sustaining the recovery and – eventually – supporting a gradual adjustment of inflation rates towards levels closer to our objective.
With our policy working, in December the asset purchase programme was extended by nine months to ensure longer support to financing conditions and a sustained return of inflation towards, but below, 2%. The volume of purchases was, however, reset to its original level of €60 billion per month. This reflected the success of our actions earlier in the year: growing confidence in the euro area economy and disappearing deflation risks.
Yet alongside these benefits, monetary policy has side-effects – it always does. In 2016 those side-effects were frequently in the spotlight. In this year’s Report we address some of the questions and concerns about the unintended consequences of our actions.
One is about their distributional effects, especially in terms of inequality. We show that, over the medium term, monetary policy has positive distributional effects by reducing unemployment, which benefits poorer households the most. After all, bringing people into a job is one of the most powerful drivers of lower inequality.
Another concern is about the profitability of banks, insurers and pension funds. We discuss how financial institutions have been affected by, and responded to, the low interest rate environment. We show that the ability of banks to adapt depends on their specific business models.
The Report covers other challenges for the financial sector in 2016. We look in particular at the problem of non-performing loans, what needs to be done to tackle it, and the obstacles which remain. We also have a special feature on new technology and innovation in the sector, how it might affect the structure and functioning of the sector, and what this means for overseers and regulators.
And no review of 2016 could be complete without considering the seismic political changes of the year, not least the decision of the United Kingdom to exit the European Union. Accordingly, the Report assesses Brexit from an ECB perspective. Above all, we emphasise the importance of preserving the integrity of the Single Market and the homogeneity of its rules and their enforcement.
Political uncertainty is likely to persist into 2017. But we remain confident that the economic recovery, buoyed by our monetary policy, will continue. The ECB has a clear mandate for its actions: to maintain price stability. This guided us successfully through 2016 – and it will continue to do so in the year to come.
Frankfurt am Main, April 2017
The euro area economy, the ECB’s monetary policy and the European financial sector in 2016
The euro area economy
The global macroeconomic environment
In 2016 the euro area economy faced a demanding external environment. Growth in both advanced and emerging market economies was modest by historical standards and there were episodes of heightened uncertainty and short-lived peaks in financial market volatility, particularly following the UK referendum on EU membership in June and the US presidential election in November. Global inflation was subdued owing to the gradually diminishing impact of past oil price declines and still abundant global spare capacity.
Global economic growth remained modest
The world economy continued to recover gradually in 2016, although at a slightly lower rate than in the previous year as a result of the deceleration in advanced economies. Economic activity only gathered pace in the second half of the year, particularly in emerging market economies. Overall, global GDP growth remained below its pre-crisis rates (see Chart 1).
2016 was marked by some significant political events, which clouded global economic prospects. In June 2016 the outcome of the UK referendum created uncertainty about the UK’s economic outlook, yet the immediate financial and economic impact proved short-lived and modest. Later in the year, the outcome of the US election brought a shift in expectations about the future policies of the incoming US administration, which led to another bout of heightened policy uncertainty.
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.
Advanced economies continued to grow, albeit at a lower rate than in the year before. Still accommodative financing conditions and improving labour markets supported economic activity. Growth in emerging market economies was also moderate for the year as a whole, with prospects improving significantly in the second half. Two factors were of particular influence: the continuing gradual deceleration of the Chinese economy, and the progressive easing of the deep recessions in major commodity-exporting economies. That said, growth remained restrained because of geopolitical tensions, excessive leverage, vulnerability to capital flow reversals and, in the case of commodity exporters, slow adjustment to lower revenues.
Global trade growth was weak in 2016, with the volume of world imports expanding by only 1.7% annually, following growth of 2.1% in the previous year. There is evidence that certain structural developments that boosted trade in the past – such as falling transportation costs, trade liberalisation, expanding global value chains and financial deepening – will not support trade to the same extent over the medium term. Accordingly, world trade is not very likely to grow faster than global economic activity in the foreseeable future.
Global financing conditions remained favourable throughout the year. Central banks in major advanced economies maintained an accommodative policy stance, with the Bank of England, the Bank of Japan and the ECB continuing their expansionary monetary policies. The US Federal Reserve System resumed its monetary policy normalisation by raising the federal funds target range by 25 basis points in December 2016. Financial markets showed overall resilience, in spite of spells of heightened uncertainty triggered by political events. Towards the year-end, US long-term bond yields increased markedly. It is still unclear whether this increase reflects higher growth and inflation expectations or rather a spike in term premia on US long-term bonds. Most emerging markets benefited from an improvement in external financing conditions until the US election in November. Thereafter, however, the earlier increase in capital flows towards emerging market economies started to unwind, with government bond spreads rising and pressures on currencies intensifying in a number of countries.
Abundant spare capacity continued to weigh on global inflation
During 2016 global inflation continued to be influenced by low oil prices and still abundant global spare capacity (see Chart 2). Annual headline inflation in the OECD area rose gradually towards the end of the year and reached 1.1% for the year as a whole, compared with 0.6% in 2015. Core annual OECD inflation (excluding food and energy) increased slightly to 1.8% (see Chart 1).