Economic and monetary developments

Overview

At its monetary policy meeting on 8 September 2016, the Governing Council assessed the economic and monetary data which had become available since the July meeting and discussed the new ECB staff macroeconomic projections. The comprehensive policy measures that have been adopted continue to ensure supportive financing conditions and underpin the momentum of the euro area economic recovery. As a result, the Governing Council continues to expect real GDP to grow at a moderate but steady pace and euro area inflation to rise gradually over the coming months, in line with the path already implied in the June 2016 staff projections. Overall, while the available evidence so far suggests resilience of the euro area economy to the continuing global economic and political uncertainty, the baseline scenario remains subject to downside risks.

Economic and monetary assessment at the time of the Governing Council meeting of 8 September 2016

Moderate global growth continued in the first half of 2016. Looking ahead, global growth is expected to recover gradually. Low interest rates, improving labour markets and growing confidence support the outlook for advanced economies, although the uncertainty generated by the referendum in the United Kingdom on EU membership will weigh on demand in that country. As regards emerging market economies, economic activity in China is expected to slow, while the outlook for large commodity exporters remains subdued, despite some tentative signs of stabilisation. Risks to the outlook for global economic activity remain on the downside.

Between early June and early September euro area and global financial markets remained relatively calm, apart from the immediate period around the UK referendum. In the period leading up to the referendum on 23 June, global financial markets exhibited increasing volatility, which spiked on the day following the referendum. Since then, financial market volatility has receded and most asset classes have recovered their losses. At the same time, long-term euro area bond yields remained significantly below their pre-referendum levels, and bank equities continued to underperform the wider market index.

The economic recovery in the euro area is continuing. Euro area real GDP increased by 0.3%, quarter on quarter, in the second quarter of 2016, after 0.5% in the first quarter. Growth was supported by net exports as well as a continued positive contribution from domestic demand. Incoming data point to ongoing growth in the third quarter of 2016, at around the same rate as in the second quarter.

Looking ahead, the Governing Council expects the economic recovery to proceed at a moderate but steady pace. Domestic demand remains supported by the pass-through of the monetary policy measures to the real economy. Favourable financing conditions and improvements in the demand outlook and in corporate profitability continue to promote a recovery in investment. Sustained employment gains, which are also benefiting from past structural reforms and still relatively low oil prices provide additional support for households’ real disposable income and thus for private consumption. In addition, the fiscal stance in the euro area is expected to be mildly expansionary in 2016 and to turn broadly neutral in 2017 and 2018. However, the economic recovery in the euro area is expected to be dampened by still subdued foreign demand – partly related to the uncertainties following the UK referendum outcome – the necessary balance sheet adjustments in a number of sectors and a sluggish pace of implementation of structural reforms.

The September 2016 ECB staff macroeconomic projections for the euro area expect annual real GDP to increase by 1.7% in 2016, by 1.6% in 2017 and by 1.6% in 2018. Compared with the June 2016 Eurosystem staff macroeconomic projections, the outlook for real GDP growth has been revised downwards slightly. In the Governing Council’s assessment, the risks to the euro area growth outlook remain tilted to the downside and relate mainly to the external environment.

According to Eurostat’s flash estimate, euro area annual HICP inflation in August 2016 was 0.2%, unchanged from July. While annual energy inflation continued to rise, services and non-energy industrial goods inflation was slightly lower than in July. Looking ahead, on the basis of current oil futures prices, inflation rates are likely to remain low over the next few months before starting to pick up towards the end of 2016, in large part owing to base effects in the annual rate of change of energy prices. Supported by the ECB’s monetary policy measures and the expected economic recovery, inflation rates should increase further in 2017 and 2018.

The September 2016 ECB staff macroeconomic projections for the euro area foreseeannual HICP inflation at 0.2% in 2016, 1.2% in 2017 and 1.6% in 2018. In comparison with the June 2016 Eurosystem staff macroeconomic projections, the outlook for HICP inflation is broadly unchanged.

The monetary policy measures in place since June 2014 are filtering through to borrowing conditions for firms and households and are thereby increasingly supporting credit flows across the euro area. Broad money continued to increase at a robust pace in July 2016 and loan growth continued to recover gradually. Domestic sources of money creation were again the main driver of broad money growth. Low interest rates and the effects of the ECB’s non-standard monetary policy measures continue to support money and credit dynamics. Banks have been passing on their favourable funding conditions in the form of lower lending rates and have eased credit standards, thereby supporting the recovery of loan growth. The annual flow of total external financing to non-financial corporations is estimated to have increased in the second quarter of 2016.


Monetary policy decisions

The Governing Council decided to keep the key ECB interest rates unchanged and continued to expect these rates to remain at present or lower levels for an extended period of time, and well past the horizon of the Eurosystem’s net asset purchases. Regarding non-standard monetary policy measures, the Governing Council confirmed that the monthly asset purchases of €80 billion are intended to run until the end of March 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 Governing Council will remain alert and ready to act, if warranted, to achieve its price stability objective. In the light of prevailing uncertainties, the Governing Council will continue to monitor economic and financial market developments very closely. It will preserve the very substantial amount of monetary support that is embedded in the ECB staff macroeconomic projections and that is necessary to secure a return of inflation to levels below, but close to, 2% over the medium term. If warranted, the Governing Council will act by using all the instruments available within its mandate. Meanwhile, the Governing Council tasked the relevant committees to evaluate the options that ensure a smooth implementation of the Eurosystem’s asset purchase programme.


External environment

The moderate global growth recorded towards the end of last year continued in the first half of 2016. Looking ahead, global growth is expected to recover gradually. Low interest rates, improving labour markets and resilient confidence support the outlook for advanced economies, although the uncertainty generated by the referendum in the United Kingdom on EU membership will weigh on demand in that country. As regards emerging market economies (EMEs), economic activity in China is expected to slow, while the outlook for large commodity exporters remains subdued, despite some tentative signs of stabilisation. Risks to the outlook for global economic activity remain on the downside.

Global economic activity and trade

Global economic growth remains moderate. Following a soft patch in the first quarter, GDP growth in the United States strengthened only modestly in the second quarter, reflecting a large drag from inventories and a further decline in investment, driven primarily by falling capital expenditure in the energy sector. Meanwhile, economic growth in the United Kingdom was more resilient in the second quarter. In contrast, the pace of expansion in Japan slowed, after leap year effects had boosted growth in the first quarter. In China, GDP growth stabilised in the second quarter, in line with the government’s annual growth target, although economic activity relied heavily on government support through infrastructure investment and continued credit growth. While short-term indicators suggest that growth rates are beginning to bottom out in Brazil and Russia, output in those countries declined further in the second quarter. Overall, recent survey indicators suggest that global economic activity will continue to expand at a modest rate. The global composite output Purchasing Managers’ Index (PMI) remained subdued in August (see Chart 1).

The outcome of the UK referendum on EU membership surprised financial markets, but volatility has been short-lived – contained, in part, by expectations of countercyclical policy responses in major advanced economies. Following the referendum the pound declined, but the impact on most global markets outside Europe has been short-lived. Capital flows to EMEs have proved resilient, amid a broad improvement in EMEs’ financial conditions, possibly linked to search-for-yield flows out of advanced economies. The Bank of England cut interest rates and announced further quantitative easing at its meeting in August. The UK government has also announced that it now expects the pace of fiscal consolidation in the country to be slower than was previously planned. In the United States, market expectations of interest rate rises by the Federal Reserve System in 2016 fell in the immediate aftermath of the referendum, before increasing again following stronger than expected labour market data. The Bank of Japan also adopted further monetary stimulus at its meeting in July, while the Japanese government announced fiscal stimulus measures in its supplementary budget for the 2016-17 fiscal year.

Chart 1

Global composite output PMI

(diffusion index)

40 50 60 70 45 50 55 60 2010 2011 2012 2013 2014 2015 2016 global excluding euro area (right-hand scale) global excluding euro area – long-term average (right-hand scale) advanced economies excluding euro area (left-hand scale) emerging market economies (left-hand scale)

Sources: Markit and ECB calculations.
Note: The latest observations are for August 2016.

Nonetheless, the result of the UK referendum has triggered an increase in macroeconomic uncertainty. In the United Kingdom, uncertainty surrounding economic policy rose. The impact on other countries has been more modest, suggesting that the vote on EU membership has resulted in a regional – rather than a global – shock. Nonetheless, other factors may also be contributing to the higher levels of political and policy uncertainty seen in other countries, particularly in the United States and China.

The weakness observed in global trade in 2015 persisted in the early part of this year. According to CPB data, the volume of world imports of goods declined by 0.8% quarter on quarter in the second quarter of 2016 (see Chart 2). Global trade has been particularly weak over the last year, partly reflecting strong declines in imports caused by deep recessions in Brazil and Russia. As these shocks unwind, the drag on global imports should lessen and global import growth should recover somewhat. Survey indicators measuring global trade also point to a modest recovery. The global PMI for new export orders rose further in August, exceeding the 50-point threshold. However, as discussed in Box 1, global trade is expected to grow at a fairly modest rate in the medium term. The decline observed in the income elasticity of global trade since 2012 is likely to persist, as the structural developments that have boosted trade in the past – falling transport costs, the liberalisation of trade, the expansion of global value chains and financial deepening – are not expected to support trade to the same extent in the future. Over the medium term, therefore, global trade growth is likely to remain well below the levels observed prior to the financial crisis.

Looking ahead, global economic growth is expected to remain moderate. In advanced economies, a combination of continued low interest rates, improvements in labour and housing markets, and resilient confidence levels are expected to support economic activity – although the heightened uncertainty seen in the United Kingdom is expected to dampen investment. Meanwhile, the gradual rebalancing of the Chinese economy is likely to weigh on growth. Capital flows to EMEs have recovered recently, but many countries are still coping with the tightening of external financing conditions associated with the expected withdrawal of monetary accommodation in the United States. The gradual easing of deep recessions in a couple of larger commodity exporters will provide some support for global growth in the years ahead, but the outlook remains subdued, as many commodity exporters face difficulties in adjusting to the low commodity price environment. Finally, increases in political uncertainty and geopolitical tensions are also weighing on demand across a number of regions.

Looking at individual countries in more detail, economic activity in the United States is expected to recover. Strong domestic fundamentals – reflected in robust job growth, modest increases in nominal wages as the economy approaches full employment, and positive household wealth effects (mostly from rising house prices) – are expected to support private consumption. Reductions in long-term interest rates and the end of the contraction in the energy sector are also expected to boost investment over the projection horizon. On the other hand, the strengthening of the US dollar and modest growth in foreign demand will weigh on exports.

The outlook for Japan remains subdued. In the short term, supply chain disruption following the earthquake in April will constrain production. Looking further ahead, however, private consumption is expected to recover amid rises in real incomes, while accommodative financial conditions should foster increases in investment. The postponement of the rise in VAT scheduled for April 2017 will support economic activity, as will the additional stimulus measures announced in the supplementary budget. In addition, monetary policy remains highly accommodative. Exports are expected to benefit from gradual improvements in foreign demand, albeit tempered by the recovery seen in the value of the yen over the last year.

The heightened uncertainty seen in the United Kingdom is expected to weigh on economic growth. The institutional and political uncertainty surrounding the negotiations to leave the European Union is expected to dampen domestic demand, particularly investment (although recent data suggest that the short-term impact of the referendum has been relatively modest thus far). Looking further ahead, monetary accommodation and a reduction in the pace of fiscal consolidation should help to support economic activity.

Real economic activity in central and eastern Europe is projected to remain relatively resilient. Private consumption is expected to be supported by increases in real disposable income and low levels of inflation. However, the uncertainty triggered by the referendum in the United Kingdom and the potential impact on the UK and euro area economies (which represent those countries’ main trading partners) are expected to weigh on output in the coming quarters.

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 62 -2 -1 0 1 2 3 4 5 6 2010 2011 2012 2013 2014 2015 2016 world trade (left-hand scale) average world trade 1991-2007 (left-hand scale) global PMI new export orders (right-hand scale) global PMI excluding euro area manufacturing (right-hand scale)

Sources: Markit, CPB and ECB calculations.
Note: The latest observations relate to August 2016 for the PMIs and June 2016 for world trade.

The growth rate of the Chinese economy is expected to moderate gradually. In the short term, resilient consumption and improvements in housing demand, combined with continued monetary accommodation and fiscal stimulus, should support the economy. Looking further ahead, however, continued emphasis on rebalancing the economy – including reductions in overcapacity in some heavy industries and action to address non-performing loans – is expected to result in a decline in the pace of economic growth.

Although output in large commodity exporters is showing signs of stabilisation, the outlook remains subdued. In Russia, financial conditions have eased following the central bank’s decision to reduce interest rates, but uncertainty remains high and business confidence remains weak. In Brazil, meanwhile, a combination of high levels of political uncertainty, tight monetary policy and financing conditions, and planned fiscal consolidation measures is expected to result in further dampening of economic activity.

Overall, the outlook for global growth continues to point to a gradual and uneven recovery. According to the September 2016 ECB staff macroeconomic projections, annual real GDP growth for the world excluding the euro area is projected to increase from 3.0% in 2016 to 3.5% in 2017 and 3.7% in 2018. Meanwhile, the annual growth rate of euro area foreign demand is expected to rise from 1.6% in 2016 to 2.6% in 2017 and 3.5% in 2018. The modest pick-up in economic activity and trade foreseen in this baseline scenario reflects resilient growth in advanced economies and a progressive easing of the deep recessions seen in a couple of large EMEs (namely Brazil and Russia), offsetting the gradual slowdown in the Chinese economy. Compared with the projections produced in June, the outlook for world GDP growth has been revised downwards slightly. However, the outlook for euro area foreign demand has been revised downwards more significantly, largely reflecting expectations of much weaker growth in imports from the United Kingdom.

Risks to the outlook for global economic activity remain on the downside, particularly for EMEs. A key downside risk is a stronger slowdown in EMEs (including China). A tightening of financing conditions and an increase in political uncertainty could exacerbate existing macroeconomic imbalances, denting confidence and resulting in an unexpectedly strong slowdown. Policy uncertainty surrounding the economic transition in China could lead to an increase in global financial volatility. Geopolitical risks also continue to weigh on the outlook. Moreover, the economic implications of the United Kingdom leaving the European Union could be worse than expected, increasing uncertainty and negatively affecting trade, business confidence and investment.


Global price developments

The effects of past declines in oil prices continue to weigh on global headline inflation. Average annual CPI inflation in OECD countries fell to 0.8% in July, from 0.9% in the previous month (see Chart 3). The energy component has continued to weigh on inflation, with average OECD inflation excluding food and energy standing at 1.8% in July. Looking at large EMEs, inflation fell in China, Brazil and Russia and rose modestly in India.

Chart 3

Consumer price inflation

(year-on-year percentage changes)

0 2 4 6 8 10 12 14 16 18 2010 2011 2012 2013 2014 2015 2016 China Brazil Russia India OECD aggregate

Sources: National sources and OECD.
Note: The latest observations relate to July 2016 for individual countries, except Russia, August 2016 and July 2016 for the OECD aggregate.

Oil prices have risen in recent months. Price dynamics have been shaped by developments on the supply side, with large outages in a number of OPEC countries (Libya, Nigeria and Venezuela) and one non‐OPEC country (Canada) dampening excess supply conditions. More recently, however, Saudi Arabian output has reached an all-time high, the decline in the supply of US shale oil has eased, and Canadian oil production has come back online earlier than expected. At the same time, global oil demand remained stronger than expected in the first half of 2016. Over the coming months, oil prices will be supported by the rebalancing of supply/demand conditions. Meanwhile, aggregate non-oil commodity prices have remained almost unchanged in the last three months.

Looking ahead, global inflation is expected to rise gradually. In the short term, the effects of past declines in oil and other commodity prices will diminish, lessening the drag on headline inflation. Looking further ahead, the upward-sloping oil futures curve points to increases in oil prices over the projection horizon. At the same time, the abundance of spare capacity at global level is expected to weigh on underlying inflation over the medium term.


Financial developments

Apart from the immediate period around the UK referendum, euro area and global financial markets remained relatively calm between early June and early September. In the period leading up to the UK referendum on 23 June, global financial markets exhibited increasing volatility, which spiked on the day following the referendum. Since then, financial market volatility has receded and most asset classes have recovered their losses. The main exceptions to this normalisation are long-term euro area bond yields, which remain significantly below their pre-referendum levels, as well as bank equities, which continue to underperform the wider market index.

The relatively tranquil developments in financial markets seen during the second quarter of 2016 have continued. Against the backdrop of timid improvements in the global economic outlook, mainly fuelled by developments in the US economy, euro area and global financial markets weathered well the immediate impact of the UK vote to leave the EU. There was an initial reaction in the euro area: the euro depreciated markedly against the US dollar, the EONIA forward curve flattened, sovereign and corporate bond spreads widened, implied volatilities went up, and equities – notably bank equities – declined. Since then, financial market volatility has receded, sovereign spreads have tightened, and most other asset classes have recovered their losses. While it cannot be ruled out that financial markets may react again when the modalities of the UK’s relationship with the EU are known with more certainty, the immediate adverse impacts of this event on financial markets were short-lived.

Chart 4

EONIA forward rates

(percentages per annum)

-0.75 -0.50 -0.25 0.00 0.25 0.50 0.75 1.00 1.25 1.50 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 7 September 2016 2 June 2016

Sources: Thomson Reuters and ECB calculations.

The euro overnight index average (EONIA) remained stable during the review period (from 2 June to 7 September), while the EONIA forward curve flattened, mainly in the wake of the UK referendum (see Chart 4). Market-based expectations of future EONIA rates have been gradually declining. On 2 June it was expected that the EONIA rate would move into positive territory in 2021, but at the end of the review period this had been pushed back by at least one year. The expected trajectory of the EONIA rate has also undergone revision. Chart 4 illustrates that the EONIA forward rate curve moved backwards in time and also further downwards during the period under review. These developments indicate that markets may be expecting additional policy accommodation. The EONIA rate ranged between -32 and -35 basis points, except at the end of the second quarter of 2016, when it temporarily rose to -29 basis points. Excess liquidity increased by around €192 billion, to around €1,040 billion, in the context of Eurosystem purchases under the expanded asset purchase programme. Box 3 presents more detailed information on euro area liquidity conditions and monetary policy operations.

While euro area long-term yields generally moved closely in line with their global counterparts prior to the UK referendum, a moderate widening of the existing wedge between rates in the United States and the euro area was seen in the post-referendum period, and UK long-term yields also declined markedly (see Chart 5). These developments are likely attributable to market perceptions of different economic situations and monetary policies across these economic areas. Amid low bond market volatility, the GDP-weighted average of ten-year euro area government bond yields hovered at low levels from end-June to 7 September. Country differences remained, with German ten-year yields being negative and further – albeit marginal – decreases in Portuguese, Spanish and Italian ten-year yields. These developments should also be seen in the light of the ECB’s ongoing public sector purchase programme.

Chart 5

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 03/15 05/15 07/15 09/15 11/15 01/16 03/16 05/16 07/16 09/16 euro area United States United Kingdom

Source: Thomson Reuters.
Notes: The item “euro area” denotes the GDP-weighted average of ten-year sovereign bond yields. The item “United States” denotes the ten-year Treasury yield. The item “United Kingdom” denotes the ten-year gilt yield. The last observation is for 7 September 2016.

Chart 6

Euro area corporate bond yields

(percentages per annum)

0.4 0.6 0.8 1.0 1.2 1.4 1.6 01/16 02/16 03/16 04/16 05/16 06/16 07/16 08/16 09/16 financials non-financials

Source: Thomson Reuters.
Note: The last observation is for 7 September 2016.

Yields on bonds issued by non-financial corporations (NFCs) continue to be positively affected by the corporate sector purchase programme (CSPP). After a downward trend in NFC bond yields, a plateau at around 0.45% seems to have been reached towards the end of July. The current levels are more than 80 basis points below those observed at the beginning of the year and can to a large extent be attributed to the CSPP (see also Box 2 in the August 2016 issue of the Economic Bulletin). Yields on bank bonds followed a similar pattern, although their decline has been less pronounced.

Global equity markets reacted strongly to the outcome of the UK referendum, with euro area banks being most affected. Euro area non-bank and US bank and non-bank equity indices have recovered the initial price drops that were seen after the UK referendum. For these equities, the prices observed at the end of the review period surpassed those seen in early June. Although euro area bank equities have displayed a strong increase since the low point that was reached on 6 July, they continue to significantly underperform the wider market, especially from a longer-term perspective.

Chart 7

Euro area and US equity price indices

(1 January 2016 = 100)

60 70 80 90 100 110 01/16 02/16 03/16 04/16 05/16 06/16 07/16 08/16 09/16 euro area banks euro area non-banks United States banks United States non-banks

Sources: Thomson Reuters and ECB calculations.
Note: The last observation is for 7 September 2016.

Chart 8

Changes in the exchange rate of the euro against selected currencies

(percentages)

-15 -10 -5 0 5 10 15 Croatian kuna Indian rupee Brazilian real Taiwan dollar Romanian leu Danish krone Hungarian forint Indonesian rupiah South Korean won Turkish lira Russian rouble Swedish krona Czech koruna Polish zloty Japanese yen Swiss franc Pound sterling US dollar Chinese renminbi EER-38 since 1 September 2015 since 2 June 2016

Source: ECB.
Notes: EER-38 is the nominal effective exchange rate of the euro against the currencies of 38 of the euro area’s most important trading partners.

In foreign exchange markets, the euro has remained virtually unchanged in effective terms. This largely reflected an appreciation of the euro by 9.3% against the pound sterling, amid heightened uncertainty after the outcome of the UK referendum, which was offset by a weakening of the euro against most other major currencies, with the exception of the US dollar. In particular, increased volatility and a decline in risk appetite supported the Japanese yen, leading to a depreciation of the euro against the Japanese currency of around 5.9%. The euro also depreciated slightly against the Swiss franc and, to a larger extent, against the currencies of most emerging market economies and commodity-exporting countries (see Chart 8).


Economic activity

Euro area real GDP growth normalised in the second quarter, after a strong outcome in the first quarter. Growth was supported by net exports as well as small continued positive contributions from domestic demand. The latest survey indicators have shown resilience and point to ongoing moderate growth in the third quarter. Looking ahead, the euro area economic recovery is expected to proceed at a moderate but steady pace. Tailwinds to domestic demand continue to come from the pass-through of the ECB’s monetary policy measures to the real economy. Favourable financing conditions, reduced leverage ratios and improvements in corporate profitability continue to promote investment. Sustained employment gains, which are also benefiting from past structural reforms, and still relatively low oil prices should provide additional support for households’ real disposable income and private consumption. In addition, the fiscal stance in the euro area is expected to be mildly expansionary in 2016 and to turn broadly neutral in 2017 and 2018. The weak external environment, the slow pace of structural reform, as well as balance sheet adjustment in a number of sectors, continue to weigh on the euro area growth outlook. Moreover, the outcome of the EU referendum in the United Kingdom is expected to further dampen euro area external demand. The September 2016 ECB staff macroeconomic projections foresee euro area real GDP growing by 1.7% in 2016 and by 1.6% in 2017 and 2018.

Chart 9

Euro area real GDP and its components

(quarter-on-quarter percentage changes and quarter-on-quarter percentage point contributions)

-1.00 -0.75 -0.50 -0.25 0.00 0.25 0.50 0.75 1.00 2010 2011 2012 2013 2014 2015 2016 GDP at market prices private consumption government consumption gross fixed capital formation net exports changes in inventories

Source: Eurostat.
Note: The latest observation is for the second quarter of 2016.

The euro area economic expansion is continuing, with real GDP growth normalising in the second quarter of 2016, following strong increases in the first quarter. Real GDP growth slowed to 0.3%, quarter on quarter, in the second quarter of 2016, down from 0.5% in the first quarter. On the production side, value added expanded by 0.3%, quarter on quarter, and was driven by industry (excluding construction) and services, whereas value added in construction fell. At the country level, real GDP came out stronger than the previous quarter in Germany, Spain and the Netherlands, while France and Italy displayed zero growth. Overall, activity was supported by a positive contribution from net exports and by a continued positive contribution from domestic demand, albeit smaller than in the previous quarter.

Private consumption, which has been the main driver of the economic recovery in recent years, rose only modestly in the second quarter. This slowdown compared with the first quarter may reflect some normalisation following the strong growth in consumption in the first quarter. Nevertheless, consumption is expected to continue to be one of the main drivers of the ongoing recovery, in particular as labour markets continue to recover and consumer confidence remains elevated.

Chart 10

Nominal labour income and private consumption

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

-2 -1 0 1 2 3 4 2010 2011 2012 2013 2014 2015 2016 private consumption compensation of employees compensation per employee employment (of employees only)

Source: Eurostat.
Notes: The latest observation is for the first quarter of 2016. Both private consumption and labour income are in nominal terms.

Recent improvements in euro area private consumption have largely been due to increases in employment. Although low oil prices have been supportive of private consumption over the past two years, labour income has increasingly become the most important driver of households’ disposable income. As the contribution of nominal wage growth to total disposable income growth has been declining somewhat in the course of the recovery, the contribution from employment, rather than wages, has boosted total nominal labour income recently (see Chart 10). This reflects the ongoing improvements in euro area labour markets, which have recovered more strongly than would be expected on the basis of movements in real GDP (see the article entitled “The employment-GDP relationship since the crisis” in this issue of the Economic Bulletin). Improving bank lending conditions, reinforced by the ECB’s monetary policy measures, should further support private consumption growth going forward. Even though low interest rates have affected interest earnings, they have also had an impact on interest payments, leaving euro area households’ net interest income largely unaffected on average. As net borrowers typically have a higher marginal propensity to consume than net savers, this redistribution of interest earnings/payments should further support aggregate private consumption (see also the box entitled “Low interest rates and households’ net interest income” in the June 2016 issue of the Economic Bulletin).

Euro area labour markets have continued to improve, as reflected in falling unemployment rates, increasing employment and elevated employment expectations. Employment continued to expand, by 0.3% quarter on quarter, in the first quarter of 2016. As a result, the level of euro area employment stood 1.4% above the level one year earlier, which represents the fastest annual increase since the first half of 2008. More timely information such as that provided by surveys continues to point to ongoing moderate improvements in euro area labour markets. Total hours worked in the euro area have lagged behind rising employment however, which is partly due to an increase in part-time employment (see also the box entitled “Factors behind developments in average hours worked per person employed since 2008” in this issue of the Economic Bulletin). As for the euro area unemployment rate, it has continued its trend decline that started at the beginning of 2013 and reached 10.1% in the second quarter of 2016, the lowest rate since mid-2011. The unemployment rate remained at this level in July. Wider measures of labour market slack – which also take into account sections of the working age population involuntarily working part-time or which have withdrawn from the labour market – remain high, and are declining at a slower rate than unemployment.

Investment growth slowed considerably in the second quarter, owing to lower industrial production of capital goods and lower construction activity. The relatively weak total investment outcome in the second quarter is likely to reflect less housing investment, following the favourable weather conditions in the previous quarter, which led to relatively higher construction output in that quarter. Weak capital goods production, in part related to the subdued external environment, was also an important factor – together with lower capacity utilisation – holding back business investment.

Chart 11

Price-to-book value ratio

0.0 0.5 1.0 1.5 2.0 2.5 3.0 2010 2011 2012 2013 2014 2015 2016 France Germany Italy Spain

Source: Thomson Reuters.
Notes: The price-to-book value ratio is used to compare a stock’s market value with its book value. A stock’s market value is a forward-looking metric that reflects a company’s future cash flows. The latest observations are for August 2016.

As euro area domestic conditions are improving, both business and construction investment are likely to recover in the near term. Overall, improving financial conditions, higher confidence in the construction sector and an increasing number of building permits issued point to a pick-up in investment growth in the third quarter. Moreover, according to the European Commission’s survey, demand has been perceived as a continuously diminishing constraint for the production of capital goods since 2013 and reached in the third quarter levels not seen since early 2012. Recovering demand, accommodative monetary policy as well as improving financing conditions should continue to boost both business and construction investment. Improving profits in recent months (see Chart 11) and the need to replace capital after years of subdued fixed capital formation should also support total investment going forward. However, uncertainty related to the EU’s future relations with the United Kingdom and the potential implications for the euro area economy might weigh on the investment outlook. In addition, deleveraging needs and a slow pace of reform implementation, particularly in some countries, as well as subdued potential growth prospects, may also dampen investment growth.

The persistent weakness in the external environment has continued to weigh on extra-euro area goods exports in 2016 (see Chart 12). The weakness in global trade has many determinants (see Box 1 in this issue of the Economic Bulletin) and one of them relates to the increasing local production in local sales markets owing to shifting patterns of global demand, labour cost issues and local content requirements (see Box 4 in this issue of the Economic Bulletin). The weak extra-euro area goods export growth in the second quarter was mainly driven by declining exports to Asia (excluding China), oil-producing nations in OPEC and Latin America. Both the United States and Russia provided broadly neutral contributions to goods export growth, whereas China and non-euro area Europe contributed positively. While still very weak, growth in extra-euro area goods exports outpaced that in global goods imports in the first half of 2016 and led to export market share gains compared with the second half of 2015, partly owing to some still positive lagged effects of movements in the effective exchange rate of the euro. These tailwinds are likely to fade gradually and signals from surveys, export orders and industrial production point to continued weak export momentum in the near term. Looking further ahead, extra-euro area exports are expected to grow more strongly following a gradual rebound in global trade.

Chart 12

Extra-euro area goods exports

(year-on-year percentage changes in the three-month moving average; percentage point contributions)

-10 -5 0 5 10 15 20 2010 2011 2012 2013 2014 2015 2016 total non-euro area Europe Asia (excluding China) Brazil, Russia, China and Turkey United States other average extra-euro export growth, 2001-15

Sources: Eurostat and ECB calculations.
Notes: The latest observation is for May 2016 for non-euro area European countries and June 2016 for all others. Extra-euro area goods exports are in volumes.

Risks to the trade outlook remain on the downside and mainly relate to adverse impacts stemming from the EU referendum in the United Kingdom. Growth in goods exports to the United Kingdom already started to lose momentum at the beginning of 2016. This has been compounded by the sizeable depreciation of the pound vis-à-vis the euro. Weaker import demand in the United Kingdom is likely to have a direct adverse impact on euro area trade, as it is one of the largest trading partners of the euro area, but also an indirect one through trade spillovers via other countries.

Overall, short-term indicators point to ongoing moderate growth in the third quarter. The European Commission’s Economic Sentiment Indicator (ESI) fell in August, and the decline was broad based across sectors and reflected a weaker assessment of the current situation as well as lower expectations. In particular, there were negative results for the assessment regarding total, as well as export, order books for manufacturing, notably in the capital goods sector, which displayed a sharp decline in August. Moreover, the composite output Purchasing Managers’ Index (PMI) edged down in August. However, the average reading for both indicators over July and August stood at broadly the same level as in the second quarter and stood above their long-term average levels, pointing to ongoing moderate growth (see Chart 13).

Chart 13

Euro area real GDP, the composite output PMI and the ESI

(quarterly growth rates and normalised percentage balances; diffusion indices)

-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2010 2011 2012 2013 2014 2015 2016 real GDP (quarter-on-quarter rates) ESI composite output PMI

Sources: Markit, European Commission and Eurostat.
Notes: The latest observations are for the second quarter of 2016 for GDP and August 2016 for the ESI and the PMI.

Chart 14

Euro area real GDP (including projections)

(quarter-on-quarter percentage changes)

-1.0 -0.5 0.0 0.5 1.0 1.5 2010 2011 2012 2013 2014 2015 2016 2017 2018 GDP projection range

Sources: Eurostat and the article entitled “September 2016 ECB staff macroeconomic
projections for the euro area”, published on the ECB’s website on 8 September 2016.
Notes: The ranges shown around the central projections are based on the differences between actual outcomes and previous projections carried out over a number of years. The width of the ranges is twice the average absolute value of these differences. The method used for calculating the ranges, involving a correction for exceptional events, is documented in “New procedure for constructing Eurosystem and ECB staff projection ranges”, ECB, December 2009, available on the ECB’s website.

Looking ahead, the economic expansion in the euro area is expected to proceed at a moderate but steady pace. Domestic demand is expected to remain resilient, supported by the ECB’s accommodative monetary policy stance and supportive fiscal policy in 2016. Investment should be promoted by further improvements in corporate profitability as well as the need to modernise the capital stock after years of subdued investment. Consumer spending is expected to be sustained by ongoing employment gains, improved bank lending conditions and the still relatively low price of oil. However, the economic recovery in the euro area is expected to be dampened by still subdued foreign demand, partly related to the uncertainties following the UK referendum outcome, the necessary balance sheet adjustments in a number of sectors and a sluggish pace of implementation of structural reforms.

The September 2016 ECB staff macroeconomic projections for the euro area foresee annual real GDP increasing by 1.7% in 2016 and 1.6% in 2017 and 2018 (see Chart 14). Compared with the June 2016 Eurosystem staff macroeconomic projections, the outlook for real GDP growth has been slightly revised downwards. The risks to the euro area growth outlook remain tilted to the downside and relate mainly to the external environment.


Prices and costs

According to Eurostat’s flash estimate, euro area annual HICP inflation stood at 0.2% in August 2016, unchanged from July. While annual energy inflation continued to rise, services and non-energy industrial goods inflation was slightly lower than in July. Looking ahead, on the basis of current futures prices for oil, inflation rates are expected to remain low over the next few months before starting to pick up towards the end of 2016, in large part owing to base effects in the annual rate of change in energy prices. Thereafter, supported by the ECB’s monetary policy measures and the expected economic recovery, inflation rates should increase further. This broad pattern is also reflected in the September 2016 ECB staff macroeconomic projections for the euro area, which foresee annual HICP inflation standing at 0.2% in 2016, 1.2% in 2017 and 1.6% in 2018. Compared with the June 2016 Eurosystem staff macroeconomic projections, the outlook for HICP inflation is broadly unchanged.

Chart 15

Euro area HICP inflation (including projections)

(annual percentage changes)

-0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2010 2011 2012 2013 2014 2015 2016 2017 2018 HICP projection range

Sources: Eurostat and the article entitled “September 2016 ECB staff macroeconomic projections for the euro area”, published on the ECB’s website on 8 September 2016.
Note: The latest observations are for the second quarter of 2016 (actual data) and the fourth quarter of 2018 (projections).

Headline inflation remained at low levels in August 2016. According to Eurostat’s flash estimate, overall HICP inflation stood at 0.2% in August, unchanged from July, with an increase in energy inflation being offset by a slight reduction in services and non-energy industrial goods inflation (see Chart 16). This followed successive increases in headline inflation from -0.2% in April to 0.2% in July, driven mainly by less negative energy inflation and higher food inflation.

Most measures of underlying inflation do not show any clear signs of an upward trend. Following increases in the first half of 2015, annual HICP inflation excluding food and energy has hovered around the 1% mark since last summer. Similarly, other measures of underlying inflation have also shown no clear signs of upward momentum (see Chart 17). This may, in part, be due to the indirect downward effects of past sharp declines in the prices of oil and other commodities. More fundamentally, domestic cost pressures – particularly wage growth – have remained subdued.

Chart 16

Contributions of components to euro area headline HICP inflation

(annual 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 2010 2011 2012 2013 2014 2015 2016 HICP food energy non-energy industrial goods services

Sources: Eurostat and ECB calculations.
Note: The latest observations are for August 2016 (flash estimates).

Pipeline pressures have remained weak. The annual growth rate of import prices for non-food consumer goods was -1.3% in July, down from -0.7% in June, and close to the recent low of -1.4% recorded in April (see Chart 18). This pattern reflects mainly the impact of developments in the euro’s nominal effective exchange rate (NEER). Further along the pricing chain, producer prices for domestic sales of non-food consumer goods remained stable, with their annual growth rate standing at 0.0% in July, unchanged from June. While the improvements seen in economic conditions are likely to have exerted upward pressure on producer prices, this may have been offset by low commodity-related input prices.

Developments in the GDP deflator suggest that domestic price pressures have strengthened since mid-2014. This reflects increases in profit margins, as labour costs have remained subdued. Those increases in profit margins likely reflect changes in terms of trade associated with falling oil prices (see the box entitled “What accounts for the recent decoupling between the euro area GDP deflator and the HICP excluding energy and food?” in this issue of the Economic Bulletin). Wage growth has remained moderate, owing to a range of factors including the still significant degree of labour market slack and weak productivity growth.[1] The annual growth rate of negotiated wages stood at 1.4% in the second quarter of 2016, unchanged from the first quarter.

Chart 17

Measures of underlying inflation

(annual percentage changes)

0.0 0.5 1.0 1.5 2.0 2.5 3.0 2010 2011 2012 2013 2014 2015 2016 HICP excluding food and energy HICP excluding food, energy, travel-related items and clothing range of underlying inflation measures

Sources: Eurostat and ECB calculations.
Notes: The range of underlying inflation measures includes the following: HICP excluding energy; HICP excluding unprocessed food and energy; HICP excluding food and energy; HICP excluding food, energy, travel-related items and clothing; the 10% trimmed mean; the 30% trimmed mean; the median of the HICP; and a measure based on a dynamic factor model. The latest observations are for August 2016 for HICP inflation excluding food and energy (flash estimate) and July 2016 for all other measures.

Chart 18

Producer prices and import prices

(annual percentage changes)

-4 -2 0 2 4 6 -10 -5 0 5 10 15 2010 2011 2012 2013 2014 2015 2016 producer price index (right-hand scale) NEER-38 (inverted; left-hand scale) extra-euro area import prices (right-hand scale)

Sources: Eurostat and ECB calculations.
Notes: Monthly data. The latest observations are for July 2016 for import prices and producer prices and to August 2016 for the NEER-38. The NEER-38 is inverted.

Market-based measures of long-term inflation expectations have declined further and remain substantially lower than survey-based measures of expectations. Market-based measures of long-term inflation expectations declined between early June and early September. The five-year forward inflation rate five years ahead declined from 1.48% in early June to 1.29% in early September (see Chart 19). Particularly sharp declines were observed around the time of the UK referendum (partly owing to technical factors relating to safe-haven flows into nominal assets). Financial market conditions subsequently normalised, but the five-year forward inflation rate five years ahead recovered only slightly from the low of 1.25% recorded on 10 July. At the same time, markets are continuing to price in only a limited risk of deflation. In contrast, survey-based measures of long-term inflation expectations for the euro area (such as the ECB’s Survey of Professional Forecasters) have remained broadly unchanged.

Looking ahead, HICP inflation in the euro area is projected to pick up towards the end of 2016, before increasing further in 2017 and 2018. On the basis of the information available in mid-August, the September 2016 ECB staff macroeconomic projections for the euro area foresee HICP inflation standing at 0.2% in 2016, before rising to 1.2% in 2017 and 1.6% in 2018 (see Chart 15).[2] Compared with the June 2016 Eurosystem staff macroeconomic projections, the outlook for HICP inflation is broadly unchanged.

Chart 19

Market-based measures of inflation expectations

(annual percentage changes)

0.0 0.5 1.0 1.5 2.0 2.5 3.0 01/14 05/14 09/14 01/15 05/15 09/15 01/16 05/16 09/16 one-year rate one year ahead one-year rate two years ahead one-year rate four years ahead one-year rate nine years ahead five-year rate five years ahead

Sources: Thomson Reuters and ECB calculations.
Note: The latest observations are for 7 September 2016.

Underlying inflation is expected to gradually rise over the projection horizon as upward pressures stemming from fading economic slack slowly build up. Improvements in labour market conditions, as reflected in a marked decline in the unemployment rate, are expected to bolster a gradual pick-up in wage growth and underlying inflation over the projection horizon. Amid the ongoing economic recovery, some further upward pressure on underlying inflation is also expected to materialise via improvements in corporations’ price-setting power and a related cyclical pick-up in profit margins. The fading of the dampening indirect effects of energy and non-energy commodity price developments should also contribute to the expected increase in underlying inflation. Upward effects can also be expected as a result of rising global price pressures more generally, but the gradual fading of upward pressures stemming from past declines in the value of the euro is expected to weigh on the pick-up in underlying inflation in the coming years. Overall, a gradual pick-up in underlying inflation should support increases in headline inflation in the course of 2017 and 2018.


Money and credit

Money growth remained robust in the second quarter of 2016 and in July. In addition, loan growth continued to recover gradually. Domestic sources of money creation were again the main driver of broad money growth. Low interest rates and the effects of the ECB’s non-standard monetary policy measures continue to support money and credit dynamics. Banks have been passing on their favourable funding conditions to lower lending rates and have eased credit standards, thereby supporting the recovery of loan growth. The annual flow of total external financing to non-financial corporations (NFCs) is estimated to have increased in the second quarter of 2016.

Broad money continued to grow at a robust pace. The annual growth rate of M3 moderated slightly to 4.8% in July 2016, having hovered around 5.0% since April 2015 (see Chart 20). The growth in M3 continued to be supported by its most liquid components, against the background of the low opportunity cost of holding these deposits in an environment of very low interest rates and a flat yield curve. In addition to the low opportunity cost of holding liquidity, robust M3 growth reflects the impact of the non-standard monetary policy measures, in particular inflows relating to the sale of securities by the money-holding sector in the context of the Eurosystem’s asset purchase programme (APP) and the targeted longer-term refinancing operations (TLTROs). The growth rate of M1 has declined during recent months, from its peak in July 2015, but still remains at a high level.

Chart 20

M3, M1 and loans to the private sector

(annual percentage changes; adjusted for seasonal and calendar effects)

-4 -2 0 2 4 6 8 10 12 14 2008 2009 2010 2011 2012 2013 2014 2015 2016 M3 M1 loans to the private sector

Source: ECB.
Notes: Loans are adjusted for loan sales, securitisation and notional cash pooling. The latest observation is for July 2016.

Chart 21

M3 and its components

(annual percentage changes; contributions in percentage points; adjusted for seasonal and calendar effects)

-8 -6 -4 -2 0 2 4 6 8 10 12 2008 2009 2010 2011 2012 2013 2014 2015 2016 M3 currency in circulation overnight deposits marketable instruments other short-term deposits

Source: ECB.
Note: The latest observation is for July 2016.

Overnight deposits, which account for around half of the amount outstanding of M3 and for the bulk of M1, continued to be the main driver of M3 growth (see Chart 21). In particular, overnight deposits of the non-financial private sector continued to grow strongly, whereas those of non-bank financial institutions continued to moderate. This distinction is important, as the leading indicator property of M1 for economic growth hinges, in particular, on dynamics observed for the non-financial sector. The growth rate of currency in circulation continued its moderating trend, i.e. there are no signs of substitution of deposits with cash by the money-holding sector, owing to very low or negative interest rates. By contrast, short-term deposits other than overnight deposits (i.e. M2 minus M1) contracted further in the second quarter of 2016 and in July. The growth rate of marketable instruments (i.e. M3 minus M2), a small component of M3, recovered somewhat during this period, supported by solid growth in money market fund shares/units and increased holdings of banks’ short-term debt securities.

Domestic sources of money creation continued to be the main driver of broad money growth. Among these, credit to general government remained the most important factor behind money creation, while credit to the private sector continued to recover gradually. The former factor reflects the ECB’s non-standard monetary policy measures, mainly the ECB’s asset purchases in the context of the public sector purchase programme (PSPP). Monetary financial institutions’ (MFIs) longer-term financial liabilities (excluding capital and reserves) – whose annual rate of change has been negative since the second quarter of 2012 – continued to decrease in the second quarter of 2016 and in July. This reflects, in particular, the impact of the new series of targeted longer-term refinancing operations (TLTRO-II), which acts as a substitute for longer-term market-based bank funding. In addition, the flat yield curve has reduced the attractiveness for investors of holding long-term deposits and bank bonds. Meanwhile, the MFI sector’s net external asset position remained the main drag on annual M3 growth, owing to continued capital outflows from the euro area; PSPP-related sales of euro area government bonds by non-residents make an important contribution to this trend, as their proceeds are invested mainly in non-euro area instruments.

Loan dynamics continued to recover gradually. The annual growth rate of MFI loans to the private sector (adjusted for loan sales, securitisation and notional cash pooling) increased further in the second quarter of 2016 and in July (see Chart 20). Loan growth improved during this period, particularly for non-financial corporations (see Chart 22), having recovered substantially from the trough of the first quarter of 2014. This improvement is broadly shared by the largest countries, though loan growth rates are still negative in some jurisdictions. In comparison, the annual growth rate of loans to households picked up slightly in the second quarter of 2016 and remained unchanged in July (see Chart 23). The significant decreases in bank lending rates seen across the euro area since summer 2014 (notably owing to the ECB’s non-standard monetary policy measures) and improvements in the supply of, and demand for, bank loans have supported these trends. However, the ongoing consolidation of bank balance sheets and still high levels of non-performing loans in some countries continue to curb loan growth.

Chart 22

MFI loans to NFCs in selected euro area countries

(annual percentage changes)

-20 -10 0 10 20 30 40 2008 2009 2010 2011 2012 2013 2014 2015 2016 euro area Germany France Italy Spain Netherlands cross-country dispersion

Source: ECB.
Notes: Adjusted for loan sales, securitisation and notional cash pooling. The cross-country dispersion is calculated on the basis of minimum and maximum values using a fixed sample of 12 euro area countries. The latest observation is for July 2016.

Chart 23

MFI loans to households in selected euro area countries

(annual percentage changes)

-10 -5 0 5 10 15 20 25 2008 2009 2010 2011 2012 2013 2014 2015 2016 euro area Germany France Italy Spain Netherlands cross-country dispersion

Source: ECB.
Notes: Adjusted for loan sales, securitisation and notional cash pooling. The cross-country dispersion is calculated on the basis of minimum and maximum values using a fixed sample of 12 euro area countries. The latest observation is for July 2016.

The further net easing of credit standards and the continued increase in loan demand by firms and households continued to contribute to the recovery of loan growth. According to the July 2016 euro area bank lending survey, competitive pressure remained the main factor behind the easing of credit standards. In addition, increasing loan demand was driven by a variety of factors[3], including the low general level of interest rates, financing needs for mergers and acquisitions and favourable housing market prospects (see survey). In this context, the main effect of the TLTROs on credit supply was through an easing impact on credit terms and conditions. Banks also reported that the additional liquidity from the TLTROs was mainly used for granting loans. Moreover, euro area banks reported that the TLTROs have had a positive impact on their profitability.

Banks’ composite cost of debt financing declined in July to a new historical low, after broadly stabilising in the second quarter of 2016 (see Chart 24).The considerable decline in July was driven mainly by a fall in bond yields, while the cost of deposits declined only marginally. The ECB’s accommodative monetary policy stance, the net redemption of MFIs’ longer-term financial liabilities, the strengthening of bank balance sheets and receding fragmentation across financial markets have contributed to the decrease in banks’ composite cost of debt financing. In line with recent developments, euro area banks reported in the July 2016 bank lending survey an improvement in access to funding via debt securities in the second quarter of 2016.

Chart 24

Banks’ composite cost of debt financing

(composite cost of deposit and unsecured market-based debt financing; percentages per annum)

0.0 1.0 2.0 3.0 4.0 5.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 euro area Germany France Italy Spain

Sources: ECB, Merrill Lynch Global Index and ECB calculations.
Notes: The composite cost of deposits is calculated as an average of new business rates on overnight deposits, deposits with an agreed maturity and deposits redeemable at notice, weighted by their corresponding outstanding amounts. The latest observation is for July 2016.


Bank lending rates for the private sector remained on a downward trend in the second quarter of 2016 and in July (see Charts 25 and 26). Composite lending rates for NFCs and households have decreased by significantly more than market reference rates since June 2014, signalling an improvement in the pass-through of monetary policy measures to bank lending rates. The decrease in banks’ composite funding costs has supported the decline in composite lending rates. Between May 2014 and July 2016, composite lending rates on loans to both euro area NFCs and households for house purchase fell by around 100 basis points. The reduction in bank lending rates was especially strong in vulnerable euro area countries, indicating receding fragmentation in euro area financial markets. Over the same period, the spread between interest rates charged on very small loans (loans of up to €0.25 million) and those charged on large loans (loans of above €1 million) in the euro area followed a downward trend. This indicates that small and medium-sized enterprises have generally been benefiting to a greater extent than large companies from the decline in lending rates.

Chart 25

Composite lending rates for NFCs

(percentages per annum; three-month moving averages)

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 euro area Germany France Italy Spain Netherlands cross-country standard deviation (right-hand scale)

Source: ECB.
Notes: The indicator for the total cost of bank borrowing is calculated by aggregating short and long-term rates using a 24-month moving average of new business volumes. The cross-country standard deviation is calculated using a fixed sample of 12 euro area countries. The latest observation is for July 2016.

Chart 26

Composite lending rates for house purchase

(percentages per annum; three-month moving averages)

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 euro area Germany France Italy Spain Netherlands cross-country standard deviation (right-hand scale)

Source: ECB.
Notes: The indicator for the total cost of bank borrowing is calculated by aggregating short and long-term rates using a 24-month moving average of new business volumes. The cross-country standard deviation is calculated using a fixed sample of 12 euro area countries. The latest observation is for July 2016.

The annual flow of total external financing to euro area NFCs is estimated to have increased in the second quarter of 2016. NFCs’ external financing now stands at levels seen at the end of 2004 (before the start of the period of excessive credit growth). The recovery in NFCs’ external financing observed since early 2014 has been supported by the strengthening of economic activity, further declines in the cost of bank lending, the easing of bank lending conditions, the very low cost of market-based debt and larger numbers of mergers and acquisitions. At the same time, NFCs’ record high cash holdings have reduced the need for external financing.

Net issuance of debt securities by euro area NFCs strengthened further in April and May 2016, before contracting in June. The strengthening in April and May was supported, among other factors, by the ECB’s monetary policy package announced in March 2016, including the corporate sector purchase programme, and was widespread across countries[4]. The June moderation was most likely related to concerns about the UK referendum. Available evidence suggests that corporate bond issuance strengthened modestly again in July and August. The net issuance of quoted shares by NFCs has remained fairly modest in recent months.

The overall nominal cost of external financing for euro area NFCs is estimated to have fallen in July 2016 to a new historical low, before returning in August to the levels observed in the second quarter of 2016. The July decline was due both to a fall in the cost of equity financing and to a decline in the cost of market-based debt financing, while the increase in August was attributable exclusively to a rise in the cost of equity financing. The cost of equity financing followed developments in equity prices and expected earnings. The cost of market-based debt financing continued to decline over the period from June to August as a consequence of the ECB’s March 2016 monetary policy measures and globally declining yields.


Fiscal developments

The euro area budget deficit is foreseen to continue to decline over the projection horizon (2016-18) mainly on the back of lower interest payments and favourable cyclical conditions. The aggregate fiscal stance for the euro area is projected to be expansionary in 2016, but to turn broadly neutral in 2017-18. While the aggregate debt-to-GDP ratio is projected to decline over the projection horizon, this masks large cross-country differences. In particular, those countries with high debt levels would need additional consolidation efforts to set their public debt ratio firmly on a downward path, while other countries with fiscal space should use this room for budgetary manoeuvre to support demand.

The euro area general government budget deficit is projected to decline gradually over the projection horizon. Based on the September 2016 ECB staff macroeconomic projections[5], the budget deficit is expected to decline from 2.1% of GDP in 2015 to 1.5% of GDP in 2018 (see the table). In 2016, lower interest payments together with favourable cyclical conditions are projected to more than offset the fiscal loosening. In 2017 and 2018, low interest payments are foreseen to remain an important driver of the deficit reduction. Compared with the June 2016 projections, the fiscal outlook remains broadly unchanged over the projection horizon.[6] More detailed information on the 2017 budgets will only become available when the euro area countries submit their draft budgetary plans by mid-October.

The euro area fiscal stance is projected to be expansionary in 2016 and to turn broadly neutral in 2017 and 2018.[7] The loosening of the aggregate fiscal stance in 2016 reflects the impact of expansionary measures on the revenue side, such as cuts in direct taxes and social security contributions in a number of euro area countries. The expansionary fiscal stance can be regarded as broadly appropriate in view of the need to find a balance between the amount of slack in the economy and the limited fiscal space, the latter in countries with high public debt. Regarding the period 2017-18, the fiscal stance is projected to be broadly neutral, as deficit-increasing measures on the revenue side are likely to be offset by less dynamically growing government primary expenditure items. The latter include, in particular, compensation of employees and intermediate consumption, which are projected to grow below nominal trend GDP growth, while other items, such as social transfers and government investment, are foreseen to grow above potential.

Table

Fiscal developments in the euro area

(percentages of GDP)

2013 2014 2015 2016 2017 2018 a. Total revenue 46.6 46.7 46.4 45.9 45.7 45.7 b. Total expenditure 49.6 49.3 48.4 47.8 47.4 47.1 of which: c. Interest expenditure 2.8 2.6 2.4 2.2 2.0 1.9 d. Primary expenditure (b - c) 46.8 46.7 46.1 45.7 45.4 45.3 Budget balance -3.0 -2.6 -2.1 -1.9 -1.7 -1.5 Primary budget balance -0.2 0.1 0.3 0.2 0.3 0.4 Cyclically adjusted budget balance -2.2 -1.9 -1.7 -2.0 -1.8 -1.6 Structural balance -2.2 -1.7 -1.6 -1.9 -1.8 -1.6 Gross debt 91.1 92.0 90.3 89.5 88.4 87.0 Memo item: real GDP (percentage changes) -0.2 1.1 1.9 1.7 1.6 1.6 (a - b) (a - d)

Sources: Eurostat, ECB and September 2016 ECB staff macroeconomic projections.
Notes: The data refer to the aggregate general government sector of the euro area. Owing to rounding, figures may not add up. The slight variation from the validated Eurostat data from spring 2016 is due to recent data revisions, which have been taken into account in the September projections.

The high euro area government debt levels are expected to fall further. The euro area debt-to-GDP ratio, which peaked in 2014, is projected to decline gradually from 90.3% of GDP in 2015 to 87.0% of GDP by the end of 2018. The projected reduction in government debt is supported by various factors, including favourable developments in the interest rate-growth differential as a result of the better macroeconomic outlook and assumed low interest rates. Small primary surpluses and negative deficit-debt adjustments will also contribute to a better debt outlook. Compared with the June 2016 projections, the euro area debt-to-GDP ratio is expected to be somewhat lower by the end of the projection horizon, which notably relates to the strong upward revision to Irish nominal GDP for 2015.[8] From a cross-country perspective, the debt-to-GDP ratio is foreseen to remain heterogeneous, with more than half of euro area countries exceeding the 60% threshold by the end of the projection horizon. Moreover, in a few countries, the government debt ratio is expected to increase further over the projection horizon.

Further consolidation efforts are essential, notably in countries with high debt-to-GDP ratios. These countries need to set their public debt ratio firmly on a downward path, as they are particularly vulnerable to renewed financial market instability or a rebound in interest rates. Euro area countries with fiscal space should, in turn, make use of the room for manoeuvre, for example by expanding public investment, while all countries should strive for a more growth-enhancing composition of government budgets.

Full compliance with the Stability and Growth Pact would support countries in correcting budgetary imbalances and thus guide them towards an appropriate debt trajectory. In this regard, on 12 July the Ecofin Council concurred with the Commission assessment that neither Portugal nor Spain had taken effective action to correct their excessive deficits by the respective deadlines of 2015 and 2016. On 2 August the Council therefore gave notice on the measures needed to be taken to correct the excessive deficit. It recommended Portugal to correct its excessive deficit this year, based on an additional fiscal effort of 0.25% of GDP, and to reduce the headline budget deficit to 2.5% of GDP. In turn, Spain was granted a two-year deadline extension to 2018, associated with a deterioration in the structural deficit of 0.4% of GDP this year and structural annual improvements of 0.5% of GDP thereafter. Both countries are invited to outline their plans on how they intend to follow up on the Council’s recommendations by 15 October. Despite the assessment that no effective action had been taken by either country, on 8 August the Council followed the Commission recommendation not to impose sanctions, which in principle should automatically apply in the event of continued non-compliance with the Pact (as introduced with the “six-pack” regulations in 2011). In an upcoming structured dialogue with the European Parliament, the Commission will outline its recommendation regarding the usage of its tool to suspend part of the structural funds in the light of Portugal’s and Spain’s non-compliance with the Pact.

Looking ahead, efforts will need to be made to ensure that the draft budgetary plans are an effective early warning and correction tool. This requires that the provisions of the “two-pack” regulations are fully and consistently applied across time and countries. Following the submission of the draft budgetary plans in mid-October, the Commission will assess whether they are in full compliance with the requirements of the Pact. In the event of non-compliance, the Commission will have to send the draft budgetary plans back to the countries concerned.


Boxes

Determinants of the slowdown in global trade: what is the new normal?

Global trade has been exceptionally weak over the past five years. Annual world import growth has been below its long-run average since mid-2011, the longest period of below-trend growth for half a century. Prior to the Great Recession, global trade grew on average roughly twice as fast as global output; since 2012 trade has barely matched the growth rates of world GDP (see Chart A). As a result, the global imports-to-GDP ratio has discontinued its strong upward trend and largely stagnated in the past five years (see Chart B). The observed decline in the gross income elasticity of trade – defined as the average growth rate of world imports divided by the average growth rate of world GDP – raises the question whether the trade weakness represents a temporary deviation from trend or a longer-lasting phenomenon reflecting more fundamental structural changes. The question has been a prominent area of recent research[9] and is highly relevant for central banks seeking to understand the role of external demand and international linkages in shaping the outlook for domestic activity, potential output and inflation. A report by experts of European central banks finds that the weakness in world trade relative to global GDP is likely to persist, being mainly driven by two developments.[10]

Chart A

Global imports and GDP growth

(annual percentage changes)

-15 -10 -5 0 5 10 15 2000 2003 2006 2009 2012 2015 imports GDP

Source: National sources and ECB staff calculations.
Notes: Imports of goods and services. Global GDP is aggregated with PPP weights.

Chart B

Ratio of global imports to GDP

(ratio of levels)

60 65 70 75 80 85 90 95 100 105 110 1995 2000 2005 2010 2015

Source: National sources and ECB staff calculations.
Notes: Global GDP is aggregated with PPP weights. The latest observation is for the fourth quarter of 2015.

First, compositional effects dampen the global income elasticity of trade. Shifts in the global trade elasticity can reflect both changes in individual country elasticities and the change in the relative weights of each country within the global aggregate. Thus, in addition to fluctuations in elasticities at the national level, changes in the global elasticity also reflect shifts in import shares and relative growth across countries with different trade intensities. In particular, the increasing importance of emerging economies, whose growth is typically less trade-intensive, has implications for the global trade elasticity.[11] The shift in trade and GDP growth from advanced economies towards emerging market economies implies a weaker relationship between trade and economic activity at the global level. This change in the geographical composition can explain about half of the decline in the global elasticity of trade between the periods 1980-2007 and 2012-15 (see Chart C). To a lesser extent, demand composition effects have also contributed to the global trade slowdown. As import-intensive GDP components – such as investment – have weakened relative to other demand components, import growth has also moderated.[12]

Chart C

Contributions to changes in global trade elasticities: 1980-2007 versus 2012-15

(left-hand scale: contributions to changes in trade elasticity;right-hand scale: global trade elasticity)

0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 Trade elasticity 1980-2007: 2.0 Trade elasticity 2012-15: 1.2 change in import shares change in regional elasticity change in relative GDP growth

Source: IRC Trade Task Force (2016) and Slopek (2015).
Notes: Analysis based on aggregates of 24 advanced and 18 emerging market economies. The blue and orange shaded areas represent the contribution of the changing geographical composition in trade and activity to the decline in the trade elasticity. The yellow area represents the decline in the elasticity that is due to a decrease of the elasticity at the regional level.

Chart D

Global value chain (GVC) participation versus share of intermediate goods in total goods imports

(index)

30 35 40 45 50 1999 2001 2003 2005 2007 2009 2011 2013 GVC participation share of intermediate goods

Source: Organisation for Economic Co-operation and Development (OECD), World Input-Output Database (WIOD) and ECB staff calculations.
Notes: Both measures exclude energy-related trade. The intermediate share is mean-variance adjusted to that of the GVC participation measure. The GVC measure is based on Borin and Mancini (2015).

Second, several developments have lowered trade elasticities at the country level. Various structural factors that boosted trade growth in the past, including falling transportation costs and the removal of trade barriers, appear to have largely run their course. Another related factor is the moderation in the expansion of global value chains (GVCs). The growing fragmentation of production processes across international borders had significantly supported gross trade, particularly in the 1990s and early 2000s when intermediate components were increasingly shipped multiple times between economies along their production chains. It appears that the sharp rise in GVCs has stalled and possibly even reversed after 2011 (see Chart D). Anecdotal evidence suggests that increasing protectionist measures such as local content requirements induce firms to increasingly source and produce in their export markets, thereby substituting for earlier trade flows.[13] Furthermore, non-linearities in the link between financial sector development and trade openness may also have contributed to the slowdown in global trade growth. Substantial financial deepening in the last three decades in many countries was associated with increasing trade openness. However, as financial sectors have matured, the positive impact of further financial deepening on trade has weakened. Future support from financial factors to global trade growth is therefore likely to be somewhat limited.

Chart E

Global (excluding euro area) imports and GDP growth

(annual percentage changes)

0 1 2 3 4 5 6 7 8 9 1995- 2007 2012 2013 2014 2015 2016 2017 2018 imports GDP

Source: National sources and ECB staff calculations.
Notes: Imports of goods and services. GDP is aggregated with PPP weights. Years 2016-18 (shaded area) reflect the most recent ECB staff projections.

Looking ahead, the structural factors seem unlikely to reverse over the medium term. The gradual shift of activity towards emerging market economies is widely anticipated to persist. Moreover, the structural developments that boosted trade in the past – falling transportation costs, trade liberalisation, expanding GVCs and financial deepening – are not expected to support trade to the same extent over the medium term.

As such, the “new normal” for the trade elasticity over the medium term is likely to be similar to the weak level observed over recent years on average. Specifically, for the world excluding the euro area, the elasticity fell from around 1.8 over the period 1995-2007 (i.e. before the crisis) to 0.9 over the period 2012-15. Part of the weakness in the recent period is due to large adverse shocks to a small number of countries, particularly Russia and Brazil, in 2015. These have pushed global trade growth significantly below the rate of GDP growth (see Chart E). As these shocks unwind, global trade growth is expected to gradually rise to levels consistent with global GDP, bringing the global trade-income elasticity (excluding the euro area) back to the “new normal” of a value around unity.


Financing constraints in euro area regions

This box presents new evidence on access to finance at regional level within the euro area. The Survey on Access to Finance of Enterprises (SAFE) has been carried out by the ECB and the European Commission since 2009 on a biannual basis. It provides information on developments in firms’ access to and use of external financing in the euro area, broken down by firm size and sector. Until now, analysis of the results of this survey has focused mainly on differences between euro area countries, disregarding heterogeneity at a regional level within countries. However, there is growing evidence that the regional dimension of access to finance is important even in integrated financial markets, particularly for small and medium-sized enterprises (SMEs). Indeed, the level of regional financial development – which often has important implications as regards the accessibility of external sources of finance – is positively correlated with growth at a regional level. At the same time, regional market conditions matter in terms of determining financing constraints that are not related to firms’ individual financial characteristics and circumstances.[14]

Financing constraints vary from region to region across the euro area. Since April 2014, information on the regions where surveyed companies are located has been collected by the SAFE survey on the basis of level 1 of the Nomenclature of Territorial Units for Statistics (NUTS). Thus, the 12 euro area countries covered by the survey are broken down into 57 major socio-economic regions.[15] Chart A shows the level of financing constraints in these various regions by firm size, based on survey results from 2014 to 2016.[16] Under the definition used in the survey, a firm is considered to be financially constrained if it applies for a bank loan or credit line and its application is rejected (or accepted only in part) or it refuses the loan or credit line on offer because the associated costs are too high. A firm is also considered to face financing constraints if it needs a bank loan or credit line but is discouraged from applying for one. The percentage of firms that have experienced financing constraints appears to vary from region to region within individual countries. In addition, smaller companies appear to be more likely to experience financing constraints in most regions, with more pronounced regional differences relative to larger companies.

Chart A

Financing constraints across regions

Micro and small enterprises (fewer than 50 employees) Medium-sized and large enterprises (50 employees or more)

(weighted percentage of firms that have experienced some form of financing constraint)

> 30% 25-30% 20-25% 15-20% 10-15% 5-10% < 5% > 30% 25-30% 20-25% 15-20% 10-15% 5-10% < 5%

Sources: SAFE survey and ECB calculations.
Note: The maps show regional aggregates at NUTS level 1 using data from the last four rounds of the SAFE survey (which were conducted between 2014 and 2016).

Market conditions at regional level affect the degree of financing constraints. Although around 60% of all regional variation in financing constraints is due to differences between countries, regional differences within countries account for almost all of the remaining 40% or so. Econometric analysis suggests that although positive developments in firms’ performance (e.g. improvements in turnover) reduce the degree of financing constraints at regional level, this correlation depends on the regional economic conditions. This is mainly the case in regions where fewer firms consider that the economic outlook has overall improved (see Chart B). As the general economic outlook for firms in a given region becomes more positive, firms’ performance becomes less relevant as a factor determining firms’ access to finance.

Chart B

Financing constraints and firms’ performance in a changing business environment

(marginal effect that improvements in turnover have on financing constraints as a function of the percentage of firms considering that the economic outlook has improved)