Economic and monetary developments

Overview

At its monetary policy meeting on 8 December 2016, based on the regular economic and monetary analyses, the Governing Council conducted a comprehensive assessment of the economic and inflation outlook and the monetary policy stance. The assessment confirmed the need to extend the asset purchase programme beyond March 2017 to preserve the very substantial amount of monetary support that is necessary to secure a sustained convergence of inflation rates towards levels below, but close to, 2% over the medium term.

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

Global activity has improved in the second half of the year and is expected to continue strengthening, although remaining below its pre-crisis pace. Continued accommodative policies and improving labour markets have supported activity in the United States, but uncertainty about the US and global outlook has increased since the US election. In Japan the pace of expansion is expected to remain moderate, while the medium-term growth prospects of the United Kingdom are likely to be restrained by heightened uncertainty related to the country’s future relations with the EU. Moreover, while the ongoing gradual deceleration of Chinese growth is likely to weigh on other emerging market economies, the gradual easing of deep recessions in some of the larger commodity-exporting countries is increasingly supporting global growth. Oil prices have risen following the OPEC agreement of 30 November and the effects of past oil price declines on global headline inflation are slowly diminishing. However, the still abundant global spare capacity is restraining underlying inflation.

Euro area sovereign yields have risen recently and the EONIA forward curve has steepened. The increase in nominal yields that has taken place since early October in part reflects the global upward trend in longer-term interest rates, which was most pronounced in the United States. The increase in nominal yields translated into a rise in the level and steepness of the EONIA forward curve. Corporate bond spreads increased slightly, but remained lower than in early March 2016, when the Eurosystem’s corporate sector purchase programme started. While broad equity prices rose marginally in the euro area, bank equity outperformed the broad index.

The economic recovery in the euro area is continuing. Euro area real GDP increased by 0.3%, quarter on quarter, in the third quarter of 2016, following similar growth in the second quarter. Incoming data, notably survey results, point to a continuation of the growth trend in the fourth quarter of 2016.

Looking further ahead, the Governing Council expects the economic expansion to proceed at a moderate but firming pace. The pass-through of the ECB’s monetary policy measures to the real economy is supporting domestic demand and has facilitated deleveraging. Improvements in corporate profitability and very favourable financing conditions continue to promote a recovery in investment. Moreover, sustained employment gains, which are also benefiting from past structural reforms, provide support for households’ real disposable income and private consumption. At the same time, there are indications of a somewhat stronger global recovery. However, economic growth in the euro area is expected to be dampened by a sluggish pace of implementation of structural reforms and remaining balance sheet adjustments in a number of sectors.

The December 2016 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 1.7% in 2016 and 2017, and by 1.6% in 2018 and 2019. Compared with the September 2016 ECB staff macroeconomic projections, the outlook for real GDP growth is broadly unchanged. The risks surrounding the euro area growth outlook remain tilted to the downside.

According to Eurostat’s flash estimate, euro area annual HICP inflation in November 2016 was 0.6%, up further from 0.5% in October and 0.4% in September. This reflected to a large extent an increase in annual energy inflation, while there are no signs yet of a convincing upward trend in underlying inflation.

Looking ahead, on the basis of current oil futures prices, headline inflation rates are likely to pick up significantly further at the turn of the year, to rates above 1%, mainly owing to base effects in the annual rate of change of energy prices. Supported by the ECB’s monetary policy measures, the expected economic recovery and the corresponding gradual absorption of slack, inflation rates should increase further in 2018 and 2019.

The December 2016 Eurosystem staff macroeconomic projections for the euro area foresee annual HICP inflation at 0.2% in 2016, 1.3% in 2017, 1.5% in 2018 and 1.7% in 2019. By comparison with the September 2016 ECB staff macroeconomic projections, the outlook for headline HICP inflation is broadly unchanged.

Low interest rates and the effects of the ECB’s non-standard monetary policy measures continue to support money and credit dynamics. Broad money growth remained stable in the third quarter of 2016 but declined somewhat in October. At the same time, loan growth to the private sector increased in October. Domestic sources of money creation remained the main driver of broad money growth. The effects of the ECB’s monetary policy measures continue to support growth in money and credit. Banks have been passing on their favourable funding conditions, leading to lower lending rates and improved credit supply, thereby contributing to the gradual recovery in loan dynamics. The annual flow of total external financing to non-financial corporations is estimated to have continued to strengthen in the third quarter of 2016.


Monetary policy decisions

In the pursuit its price stability objective, the Governing Council took the following decisions:

  • As regards non-standard monetary policy measures, the Eurosystem will continue to make purchases under the asset purchase programme (APP) at the current monthly pace of €80 billion until the end of March 2017. From April 2017, net asset purchases are intended to continue at a monthly pace of €60 billion until the end of December 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. If, in the meantime, the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation, the Governing Council intends to increase the programme in terms of size and/or duration. The net purchases will be made alongside reinvestments of the principal payments from maturing securities purchased under the APP.
  • To ensure the continued smooth implementation of the Eurosystem’s asset purchases, the Governing Council decided to adjust the parameters of the APP as of January 2017 as follows. First, the maturity range of the public sector purchase programme will be broadened by decreasing the minimum remaining maturity for eligible securities from two years to one year. Second, purchases of securities under the APP with a yield to maturity below the interest rate on the ECB’s deposit facility will be permitted to the extent necessary.
  • The key ECB interest rates were kept unchanged and the Governing Council continues to expect them to remain at present or lower levels for an extended period of time, and well past the horizon of net asset purchases.

The extension of the APP has been calibrated to preserve the very substantial degree of monetary accommodation necessary to secure a sustained convergence of inflation rates towards levels below, but close to, 2% over the medium term. Together with the sizeable volume of past purchases and forthcoming reinvestments, it ensures that financial conditions in the euro area will remain very favourable, which continues to be crucial to achieve the ECB’s objective. In particular, the extension of Eurosystem purchases over a longer horizon allows for a more sustained market presence and, therefore, a more lasting transmission of the ECB’s stimulus measures. This calibration reflects the moderate but firming recovery of the euro area economy and still subdued underlying inflationary pressures. The Governing Council will closely monitor the evolution of the outlook for price stability and, if warranted to achieve its objective, will act by using all the instruments available within its mandate.


External environment

Global activity has improved in the second half of this year and is expected to continue strengthening, although remaining below its pre-crisis pace. Global inflation is still dampened by the effects of past oil price declines and the abundant global spare capacity is expected to weigh on underlying inflation over the medium term.

Global economic activity and trade

Global activity has improved in the second half of this year. Data released in the past few months suggest relatively stable expansion in advanced economies and a slight improvement in emerging market economies (EMEs). The medium-term outlook for global activity remains one of strengthening growth, albeit below its pre-crisis pace. The global outlook continues to be overshadowed by several factors, including the adverse effect of low commodity prices on commodity-exporting countries, the gradual rebalancing of the Chinese economy, and growing policy uncertainty in the United States.

Financial markets have shown resilience in advanced economies, while signs of pressure seem to be emerging in some EMEs. US long-term bond yields have increased markedly owing partly to market expectations of higher inflation associated with possible fiscal stimulus. Volatility in stock markets has diminished in the last few weeks and stock markets in advanced economies have gained some momentum. Emerging market economies have benefited from an improvement in financing conditions in recent quarters, but since the US election in November the return of capital flows towards EMEs has started to unwind, EME government bond spreads have increased and pressures on EME currencies have intensified.

Monetary policies remain accommodative. The federal funds futures curve has shifted upwards in recent months, partly reflecting the anticipation of more expansionary fiscal policies in the United States (see Chart 1). By contrast, the Bank of England cut interest rates and announced further quantitative easing at its meeting in August, and the Bank of Japan introduced some changes to its monetary framework in September, i.e. yield curve control and commitment to overshoot its inflation target.

Recent data releases point to a strengthening in global economic activity in the second half of the year. Excluding the euro area, the global composite output Purchasing Managers’ Index (PMI) remained unchanged in November, at 53.3, pointing to solid global growth in the last quarter of the year (see Chart 2). Developments in November were positive across most advanced and emerging market economies. Along the same lines, OECD coincident leading indicators point to stable growth momentum in advanced economies, but to improving growth momentum in major emerging economies. Overall, growth appears to be holding up in advanced economies and seems to have bottomed out in EMEs.

Chart 1

Policy rates expectations

(percentages)

-0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 01/17 04/17 07/17 10/17 01/18 04/18 07/18 10/18 US 7 December US 8 September UK 7 December UK 8 September JP 7 December JP 8 September

Sources: Bloomberg and Bank of England.

Chart 2

Global composite output PMI

(diffusion index)

48 50 52 54 56 58 60 2010 2011 2012 2013 2014 2015 2016 global excluding euro area global excluding euro area – long-term average advanced economies excluding euro area emerging market economies

Sources: Haver Analytics and ECB staff calculations.
Notes: The latest observations are for November 2016. Emerging market economies is an aggregate of China, Russia, Brazil, India and Turkey. Advanced economies includes the United States, the United Kingdom and Japan. Long-term average refers to the period from January 1999 until November 2016.

Economic activity in the United States improved markedly in the third quarter of 2016, following modest growth in the first half of the year. Net exports and inventory investment rebounded strongly and made an important contribution to real GDP growth in the third quarter, while private fixed investment remained weak and consumer spending softened. Looking forward, growth is expected to expand at a moderate pace, supported by improved economic fundamentals. Policy uncertainty resulting from the US presidential election has increased. As expectations for fiscal stimulus have risen, this led to some tightening in financial conditions, in particular long-term rates.

In the United Kingdom, despite heightened uncertainty in the immediate aftermath of the referendum on EU membership, economic activity in the third quarter was resilient. GDP growth in the third quarter was supported by robust consumption and a large contribution from net trade, while investment held up well. However, uncertainty about the future EU-UK trade relationship is projected to be a drag on investment, while the recent depreciation of the pound sterling will weigh on consumption.

In Japan, although real GDP grew at a robust pace in the third quarter, underlying economic activity continues to advance modestly. Headwinds from soft foreign demand and weak private consumption prevail. Looking ahead, accommodative financial conditions and positive corporate profits should spur investment. Exports are expected to pick up gradually as foreign demand increases despite the past appreciation of the yen. By contrast, private consumption is expected to continue at a modest pace. Fiscal stimulus measures are expected to support domestic demand over the next few years.

China’s growth stabilised in the third quarter of the year, supported by strong consumption and infrastructure spending. While the near-term outlook is dominated by the extent of the policy stimulus, economic growth is expected to remain on a gradual downward trend in the medium term. Investment growth will continue to moderate as overcapacity is gradually cut back. Consumption is foreseen to be the main driver of growth.

Real economic activity in central and eastern Europe is projected to remain relatively resilient across most of the region. It is expected to benefit from strong investment supported by EU structural funds as well as dynamic private consumption driven by higher real disposable income and improving labour markets in a low inflation environment.

Output in large commodity exporters is showing signs of a rebound, following the deep recessions. Available data suggest some improvement in economic activity in Russia. Financial conditions have eased as the central bank has reduced policy rates due to the ongoing disinflation process, but uncertainty remains high and consumer confidence is weak. Although the rebound in oil prices will provide some respite, necessary fiscal consolidation will weigh on the business environment. In Brazil the deep and protracted recession is expected to slowly bottom out in the second half of the year, amid reduced political uncertainty and loosening financial conditions. On the other hand, large fiscal consolidation needs are expected to weigh on the medium-term outlook.

Global trade has gained some momentum in the second half of this year. Excluding the euro area, global imports were revised slightly upwards in the first half of 2016 and available indicators point to positive signals about short-term prospects. According to data from the Netherlands Bureau for Economic Policy Analysis (CPB), following two quarters of negative growth, the volume of world imports of goods increased by 0.7% in the third quarter (see Chart 3). The global PMI for new export orders increased further in November, pointing to improving global trade momentum in the last quarter of the year. Looking further ahead, world trade is expected to expand in line with the recovery in global activity. The slowdown in trade in the past few years is mostly structural and likely to persist.[1] Therefore it is assumed that the medium-term elasticity of global imports to GDP growth remains significantly below pre-crisis levels.

Chart 3

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) world trade 1991 - 2007 average (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 are for November 2016 (PMIs) and September 2016 (trade).

Overall, global growth is projected to increase gradually over 2016-19. According to the December 2016 Eurosystem staff macroeconomic projections, world real GDP growth excluding the euro area is projected to accelerate gradually from 3.0% in 2016 to 3.5% in 2017, 3.7% in 2018 and 3.8% in 2019. Euro area foreign demand growth is expected to increase from 1.5% in 2016 to 2.4% in 2017, 3.4% in 2018 and 3.6% in 2019. Compared to the September 2016 projections, global growth remains broadly unchanged, while euro area foreign demand growth has been revised slightly downwards, mainly owing to lower import growth in some advanced economies.

The uncertainty surrounding the baseline projections for global activity has increased recently but the balance of risks remains tilted to the downside, particularly for EMEs. On the upside, the possible adoption of a more expansionary US fiscal policy stance could provide support to the US and global economies. Downside risks include a possible rise in trade protectionism and a tightening in global financial conditions, which could expose countries with prevailing internal or external imbalances to intensified financial market pressures. An unwinding of excess leverage in EMEs, in particular in China, could also prompt slower domestic demand growth, raise financial stability concerns and trigger capital outflows. Finally, geopolitical risks continue to exist.


Global price developments

The effects of past oil price declines continue to weigh on global headline inflation, although the impact is slowly diminishing. In the OECD countries, annual consumer price index (CPI) inflation increased to 1.4% in October, from 1.2% the previous month, on the back of less negative growth in both energy and food prices. Although remaining at low levels, this represents a significant increase relative to the first half of the year, when CPI inflation was, on average, 0.9%. Excluding food and energy, OECD annual inflation declined slightly in October, to 1.7% (see Chart 4). Among advanced economies, headline inflation increased in the United States, Japan and Canada, while it decreased modestly in the United Kingdom. In major non-OECD economies, inflation declined in India, Brazil and Russia, while it increased in China.

Chart 4

OECD consumer price inflation

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

-2 -1 0 1 2 3 4 5 2008 2009 2010 2011 2012 2013 2014 2015 2016 energy contribution food contribution excluding food and energy contribution excluding food and energy all items

Source: OECD.
Note: The latest observation is for October 2016.

The price of oil increased markedly after the OPEC meeting on 30 November. Earlier, the OPEC announcement of its intention to reinstate a production quota fostered uncertainty in the market. Following the coordinated decision by OPEC and some non-OPEC producers to cut production in the first half of 2017, by 1.2 and 0.6 million barrels per day respectively, the price of Brent crude oil soared by more than 10% to USD 52 per barrel on 7 December (from USD 46 on 29 November). Looking forward, record-high inventories still act as a buffer against large price increases, but the combined supply restriction will favour a smooth destocking of inventories. Box 1 reviews OPEC’s new supply strategy and discusses the outlook for oil prices in the short to medium run under alternative supply patterns. Aggregate non-oil commodity prices rose robustly driven by the reaction of metal prices to news of China’s demand remaining strong and, more recently, to the announcement of new investments in infrastructure in the United States.

Global inflation is expected to rise slowly going forward. The effects of past falls in oil and other commodity prices are anticipated to continue diminishing, lessening the drag on headline inflation. Further ahead, the upward sloping oil futures curve anticipates increases in oil prices over the projection horizon. On the other hand, still abundant global spare capacity is expected to weigh on underlying inflation for some time to come.


Financial developments

Since the Governing Council monetary policy meeting in September, euro area sovereign yields have risen and the EONIA forward curve has steepened. The increase in nominal yields has taken place mainly on account of higher inflation expectations. Corporate bond spreads increased slightly, but remained lower than in early March 2016, when the corporate sector purchase programme (CSPP) was announced. Broad equity prices rose marginally in the euro area, while bank equity prices outperformed the broad index.

Chart 5

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

(percentages per annum)

-0.5 0 0.5 1 1.5 2 2.5 3 01/15 07/15 01/16 07/16 euro area United States United Kingdom

Sources: Bloomberg and ECB.
Note: For the euro area, the GDP-weighted average of ten-year euro area sovereign bond yields is reported.

Long-term euro area government bond yields have risen since early September. During the review period (from 8 September to 7 December 2016), the euro area ten-year overnight index swap (OIS) rate rose by around 50 basis points to 0.35%. Over the same period, the GDP-weighted ten-year euro area sovereign bond yield also rose by 50 basis points, to just above 1% (see Chart 5). The increase in interest rates started in early October and reversed around half of the sizeable decline in euro area OIS yields that had taken place since the beginning of the year. This brought the ten-year OIS rate back to the level seen in mid-February. Across countries, ten-year sovereign yields also rose, by between 40 and 90 basis points, while sovereign spreads vis-à-vis the German Bund ten-year rate widened by between 5 and 50 basis points, with the exception of Greece, where spreads declined by over 200 basis points. The largest increase in sovereign spreads took place in Italy and was mainly associated with political uncertainty stemming from the country’s constitutional referendum held on 4 December.

The increases in euro area OIS and sovereign yields since early October reflected in part the global upward trend in longer-term interest rates. This trend was most pronounced in the United States, where yields rose mainly on the back of increasing market expectations of higher inflation associated with possible fiscal stimulus and protectionism, with likely implications for the course of monetary policy. In the euro area, higher yields first mainly reflected a rise in real interest rates. After the US presidential election, however, inflation expectations played a leading role in the rise in nominal yields.

The increase in nominal yields translated into a significant rise in the level and steepness of the EONIA forward curve. A sizeable change has occurred in the shape and position of the EONIA forward curve since early October, with the steepness of the curve rising by around 60 basis points over the review period (see Chart 6). Changes in the shape of the curve suggest that the higher nominal yields over the review period also stemmed from reduced expectations of ECB policy accommodation. This can be seen from the disappearance of the downward-sloping shorter segment of the curve, which turned flat, indicating that market participants do not expect further deposit facility rate cuts. The EONIA remained stable during the review period at around -35 basis points. In line with the usual pattern, the EONIA temporarily rose to -32 basis points around the end of the third quarter of 2016. During the review period, excess liquidity in the banking sector[2] increased by around €147 billion to €1,185 billion, driven mainly by purchases under the Eurosystem’s expanded asset purchase programme. Box 2 contains more detailed information on developments in euro area liquidity conditions and monetary policy operations.

Chart 6

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