Economic and monetary developments

Overview

At its monetary policy meeting on 9 March 2017, the Governing Council concluded that a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to build up and support headline inflation in the medium term. The ECB’s monetary policy measures have continued to preserve the very favourable financing conditions that are necessary to secure a sustained convergence of inflation rates towards levels below, but close to, 2% over the medium term. The ongoing pass-through of these measures to borrowing conditions for firms and households benefits credit creation and supports the steadily firming recovery of the euro area economy. Headline inflation has again increased, largely on account of rising energy and food price inflation. However, underlying inflation pressures continue to remain subdued. The Governing Council will continue to look through changes in HICP inflation if judged to be transient and to have no implication for the medium-term outlook for price stability.

Economic and monetary assessment at the time of the Governing Council meeting of 9 March 2017

Global activity has continued its recovery. Global growth improved in the second half of last year and is expected to have remained sustained at the start of 2017, albeit at a modest pace from a historical perspective. Global headline inflation has increased in recent months, following the rebound in oil prices, while slowly diminishing spare capacity is expected to give some support to underlying inflation over the medium term.

Since the Governing Council’s monetary policy meeting in December 2016 euro area sovereign bond yields have risen slightly and have exhibited some volatility. Corporate bond spreads have fallen and remain lower than the levels recorded in early March 2016 when the corporate sector purchase programme was announced. Broad equity prices have risen in the euro area and a similar increase has been observed in the United States. The value of the euro has depreciated slightly in trade-weighted terms.

The economic recovery in the euro area is steadily firming. Euro area real GDP increased by 0.4%, quarter on quarter, in the fourth quarter of 2016, following a similar pace of growth in the third quarter. Incoming data, notably survey results, have increased the Governing Council’s confidence that the ongoing economic expansion will continue to firm and broaden.

Looking ahead, the pass-through of the ECB’s monetary policy measures is supporting domestic demand and facilitates the ongoing deleveraging process. The recovery in investment continues to be promoted by very favourable financing conditions and improvements in corporate profitability. Moreover, rising employment, which is also benefiting from past structural reforms, is having a positive impact on households’ real disposable income, thereby providing support for private consumption. In addition, there are signs of a somewhat stronger global recovery and increasing global trade. 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 adjustment needs in a number of sectors.

The March 2017 ECB staff macroeconomic projections for the euro area foresee annual real GDP increasing by 1.8% in 2017, by 1.7% in 2018 and by 1.6% in 2019. Compared with the December 2016 Eurosystem staff macroeconomic projections, the outlook for real GDP growth has been revised upwards slightly for 2017 and 2018. The risks surrounding the euro area growth outlook have become less pronounced, but remain tilted to the downside and relate predominantly to global factors.

According to Eurostat’s flash estimate, euro area annual HICP inflation increased further to 2.0% in February, up from 1.8% in January 2017 and 1.1% in December 2016. This reflected mainly a strong increase in annual energy and unprocessed food price inflation, with no signs yet of a convincing upward trend in underlying inflation. Looking ahead, headline inflation is likely to remain at levels close to 2% in the coming months, largely reflecting movements in the annual rate of change of energy prices.

Measures of underlying inflation, however, have remained low. They are expected to rise only gradually over the medium term, supported by the ECB’s monetary policy measures, the expected continuing economic recovery and the corresponding gradual absorption of slack.

The March 2017 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation at 1.7% in 2017, 1.6% in 2018 and 1.7% in 2019. By comparison with the December 2016 Eurosystem staff macroeconomic projections, the outlook for headline HICP inflation has been revised upwards significantly for 2017 and slightly for 2018, while remaining unchanged for 2019. The staff projections are conditional on the full implementation of all the ECB’s monetary policy measures.

The ECB’s monetary policy measures put in place since June 2014 are providing significant support for borrowing conditions for firms and households and thereby credit flows across the euro area. Broad money growth remained generally stable in January 2017. At the same time, lending to the private sector continued its gradual recovery in the fourth quarter of 2016 and in January. Low interest rates and the effects of the ECB’s non-standard monetary policy measures continue to support the financing conditions of the real economy. The annual flow of total external financing to non-financial corporations is estimated to have strengthened further in the fourth quarter of 2016.

Over the coming years, the general government budget deficit and debt ratios for the euro area are projected to remain on a downward path. The euro area fiscal stance, which was mildly expansionary in 2016, is projected to turn broadly neutral in 2017-19. However, euro area countries’ follow-up to the European Commission’s review of their draft budgetary plans for 2017 has been unsatisfactory, as none the countries that were considered at risk of non-compliance with the Stability and Growth Pact has implemented significant measures.


Monetary policy decisions

Based on the regular economic and monetary analyses, the Governing Council confirmed the need for a continued very substantial degree of monetary accommodation to secure a sustained return of inflation rates towards levels that are below, but close to, 2% without undue delay. The Governing Council decided to keep the key ECB interest rates unchanged and continues to expect them to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases. Regarding non-standard monetary policy measures, the Governing Council confirmed that it 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 and that, from April 2017, the 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. The net purchases will be made alongside reinvestments of the principal payments from maturing securities purchased under the APP. Moreover, the Governing Council confirmed that if the outlook became less favourable, or if financial conditions became inconsistent with further progress towards a sustained adjustment in the path of inflation, it would stand ready to increase the asset purchase programme in terms of size and/or duration.


External environment

Global activity improved in the second half of last year and growth is expected to remain sustained in the first quarter of 2017, albeit at a modest pace when seen in historical perspective. Global headline inflation has increased in recent months, following the rebound in oil prices, while slowly diminishing spare capacity is expected to give some support to underlying inflation over the medium term.

Global economic activity and trade

Global growth is expected to remain sustained, albeit modest by historical comparison. Recent data releases confirm the improvement in global economic activity in the second half of 2016 and point to sustained growth in early 2017. Looking forward, both advanced economies and emerging market economies (EMEs) are anticipated to support growth. In particular, fiscal policy stimulus is expected to strengthen activity in the United States while the gradual easing of deep recessions in some of the larger commodity exporters will support growth in EMEs. However, uncertainty remains elevated owing to a number of factors, including the design of the new US administration’s policies and their effects on the US economy and any spillovers to global activity; the strength of the recovery in commodity exporters; the gradual rebalancing of the Chinese economy; and future relations between the United Kingdom and the European Union.

Although financial conditions have overall remained supportive, they tightened in some EMEs. Volatility has remained low across financial markets in the last few weeks, with stock markets in advanced economies recording further gains. US long-term bond yields rose slightly, while remaining at low levels in other advanced economies. By contrast, financial conditions tightened in some EMEs, as sovereign spreads increased and currencies depreciated, particularly the Turkish lira and the Mexican peso. Capital outflows from EMEs overall showed some relief, being less persistent than in previous episodes of uncertainty; however, outflows from China were significant in December, halted only by strong control measures from authorities. Box 1 analyses financial market developments in EMEs since the US election and compares them with the “taper tantrum” episode of 2013.

Monetary policies remained accommodative, but divergence across advanced economies is increasing. The federal funds futures curve has shifted upwards in recent months, following the Federal Open Market Committee’s decision in December. By contrast, the stance of the Bank of England and of the Bank of Japan remained accommodative (see Chart 1). This divergence, which reflects heterogeneous economic performance across advanced economies, has also been reflected in exchange rate adjustments.

Chart 1

Policy rates expectations

(percentages)

-0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 04/17 06/17 08/17 10/17 12/17 02/18 04/18 06/18 08/18 10/18 8 March 2017 (United States) 8 December 2016 (United States) 8 March 2017 (United Kingdom) 8 December 2016 (United Kingdom) 8 March 2017 (Japan) 8 December 2016 (Japan)

Sources: Bloomberg and Bank of England.

Recent data releases confirm a sustained momentum in global growth in the last quarter of 2016. Excluding the euro area, the global composite output Purchasing Managers’ Index (PMI) rose to 53.3 in the fourth quarter of 2016, from 51.5 in the previous quarter, pointing to a recovery in global growth in the second half of last year. The global composite output PMI at the start of 2017 reaffirmed this trend (see Chart 2). At the country level, quarterly PMIs rose in all major advanced economies in the last quarter of 2016. Among EMEs, quarterly figures also edged higher in China and Russia, but retreated in India – in the aftermath of the recent demonetisation policy – and in Brazil, remaining below the 50-level threshold in both of these countries. Looking forward, composite leading indicators of the Organisation for Economic Co-operation and Development (OECD) continue to suggest a pick-up in growth momentum in several advanced economies and signal the build-up of growth momentum in major EMEs.

Chart 2

Global composite output PMI

(diffusion index)

48 50 52 54 56 58 60 2010 2011 2012 2013 2014 2015 2016 2017 global excluding euro area global excluding euro area long - term average advanced economies excluding euro area EMEs

Sources: Haver Analytics and ECB staff calculations.
Notes: The latest observations are for February 2017. “EMEs” is an aggregate of China, Russia, Brazil, India and Turkey. “Advanced economies” comprises the United States, the United Kingdom and Japan. “Long-term average” refers to the period from January 1999 to February 2017.

Economic activity in the United States ended the year on a more solid note, supported by consumer spending and a recovery in investment, as the adjustment in the energy sector and the negative effects of the strong dollar on firms’ profitability diminished. Solid consumer spending and a recovery in private investment should support a moderate expansion in 2017. Thereafter, economic activity is expected to expand at a stronger pace, mostly on account of a more expansionary fiscal stance that is likely to be pursued by the new administration.

In the United Kingdom, economic activity has been surprisingly resilient in the aftermath of the referendum on EU membership. While investment stagnated in the last quarter of 2016 amid the “Brexit”-related uncertainty, private consumption contributed significantly to GDP growth, its slowdown compared with the previous quarter notwithstanding. However, economic activity is expected to slow down over the course of 2017. The exchange-rate driven increase in consumer prices is expected to curtail private consumption, while firms’ investment decisions are likely to be affected by the uncertainty surrounding Brexit.

In Japan, real GDP decelerated in the last quarter of 2016, as domestic demand weakened. Net exports supported by a weaker yen and recovering activity abroad contributed more to real GDP growth than did domestic demand. In the short-term horizon, growth should be supported by significant fiscal and monetary policies stimuli as well as foreign demand. Looking further ahead, as support from last year’s fiscal stimulus package gradually vanishes, economic activity is expected to decelerate over time towards the potential output growth rate.

China’s growth strengthened in the last quarter of 2016, supported by strong consumption and the recovery in private investment. The near-term outlook is dominated by the extent of the policy stimulus, but in the medium term economic growth is expected to remain on a gradual downward trend. In particular, investment growth will continue to moderate as overcapacity is gradually cut back.

Real GDP growth in central and eastern Europe decelerated over 2016 due to the slower drawdown of EU funds at the beginning of the new budget period. Weaker external demand has also contributed to the slowdown. However, in the medium term, economic activity is projected to remain relatively resilient, on the back of solid consumer spending, improving labour markets and higher absorption of EU funds.

Signs of a rebound from the deep recessions in large commodity exporters are mixed. In Russia, quarterly real GDP growth turned positive in the third quarter of 2016, supported mainly by net exports. While the central bank has kept its key interest rate unchanged, the Russian rouble strengthened and equity markets surged on the back of the rebound in oil prices. However, going forward, fiscal challenges are expected to weigh on the business environment and the lack of fixed investment and structural reforms may well undermine growth potential. In Brazil, real GDP dropped more than expected in the second half of 2016. Economic activity in the near term should benefit from slowly stabilising business confidence, improving terms of trade and loosening financial conditions; however, recurring political uncertainties and fiscal consolidation needs continue to weigh on the medium-term outlook.

Global trade improved in the second half of 2016 and is expected to maintain its momentum in the first quarter of this year. Excluding the euro area, global imports were revised slightly upwards in the third quarter of 2016, confirming the rebound from the first half, and available indicators suggest positive short-term prospects. According to data from CPB Netherlands Bureau for Economic Analysis (CPB), the volume of world imports of goods increased by 0.6% in December (in three-month-on-three-month terms), slightly below the pace in the third quarter but still pointing to sustained growth (see Chart 3). The global PMI for new export orders has continued to increase in the last few months, pointing to improving global trade momentum at the start of this year. Further ahead, while the outlook is subject to some uncertainties regarding the United States’ future trade policies, world trade is expected to expand broadly in line with global activity.

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 2017 world trade (left - hand scale) world 1991 - 2007 average (left - hand scale) global PMI manufacturing excluding euro area (right - hand scale) global PMI new export orders (right - hand scale)

Sources: Markit, CPB and ECB calculations.
Note: The latest observations are for February 2017 (PMIs) and December 2016 (trade).

Overall, global growth is projected to increase gradually over the period 2016‑19. According to the March 2017 ECB staff macroeconomic projections, world real GDP growth excluding the euro area is projected to accelerate from 3.1% in 2016 to 3.5% in 2017 and 3.8% in 2018-19. Euro area foreign demand growth is expected to increase from 1.6% in 2016 to 2.8% in 2017, 3.4% in 2018 and 3.5% in 2019. Compared with the December 2016 projections, global growth has been revised slightly upwards, reflecting some data revisions and the inclusion of the expectation of some fiscal stimulus in the US baseline projection. Meanwhile euro area foreign demand growth has been revised upwards in 2016-17, reflecting stronger import data in the second half of 2016; but marginally downwards in 2019, largely on account of expectations of weaker import growth in Latin America and China.

The uncertainty surrounding the baseline projections for global activity remains elevated, with the balance of risks tilted to the downside. Key downside risks include an increase in trade protectionism that is gaining strength across advanced economies; a disorderly tightening of global financial conditions, which could affect in particular vulnerable EMEs; possible disruptions associated with China’s reform and liberalisation process; and, lastly, possible disruptions caused by political and geopolitical uncertainties, such as future relations between the United Kingdom and the European Union.


Global price developments

Global headline inflation increased in recent months, following the rebound in oil prices. In the OECD countries, annual consumer price index (CPI) inflation increased to 2.3% in January, going back to levels not seen in almost five years. This was mainly driven by the increase in energy prices, which rose by 8.5% year on year. Excluding food and energy, OECD annual inflation increased to 1.9% in January from 1.8% in December (see Chart 4). Consumer price inflation increased further in all major advanced economies in January. Conversely, inflation continued to decline in most major non-OECD economies, with the exception of China where consumer prices picked up.

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 2017 all items excluding food and energy excluding food and energy contribution food contribution energy contribution

Source: OECD.
Note: The latest observation is for January 2017.

Brent crude oil prices have fluctuated in the range of USD 52 to USD 56 per barrel since the agreement of the Organization of the Petroleum Exporting Countries (OPEC) on 30 November 2016 to cut output. Global oil production dropped in January, mirroring declines in both OPEC and non-OPEC countries. While OPEC production recorded one of the largest output cuts in its history, non‑OPEC members participating in the output deal also contributed to what was the biggest month-on-month decline in global oil supply since September 2008. However, looking forward, non-OPEC output is set to increase in 2017 driven mainly by countries outside the output deal (the United States, Canada and Brazil), with US shale production already showing production increases in December 2016. Non-oil commodity prices have increased by around 1% (in US dollar terms) over the past few weeks, mainly driven by a rise in the price of iron ore to a near three-year high, which was partly offset by a fall in food prices.

Looking ahead, global inflation is expected to rise slowly. The recent increase in oil and other commodity prices are expected to support headline inflation in the short term. Further ahead, slowly diminishing spare capacity at the global level is expected to give some support to underlying inflation over the medium term. However, as the current oil futures curve anticipates very stable oil prices over the projection horizon, the future contribution from energy prices to inflation is expected to be very limited.


Financial developments

Since the Governing Council’s monetary policy meeting in December, euro area sovereign bond yields have risen slightly and exhibited some volatility. Corporate bond spreads have fallen and remain at levels lower than in early March 2016, when the corporate sector purchase programme (CSPP) was announced. Broad equity prices have risen in the euro area, with a similar increase observed in the United States. The value of the euro depreciated slightly in trade-weighted terms.

Long-term euro area government bond yields have overall increased since early December. During the period under review (from 8 December 2016 to 8 March 2017), the GDP-weighted ten-year euro area sovereign bond yield increased by around 15 basis points to approximately 1.2% (see Chart 5).

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 11/16 01/17 03/17 euro area United Kingdom United States

Sources: Bloomberg and ECB calculations.
Notes: For the euro area, the GDP-weighted average of ten-year euro area sovereign bond yields is reported. The latest observation is for 8 March 2017.

Within the euro area, sovereign yield spreads have widened as a result of political uncertainty. The overall stable developments in the GDP-weighted average of sovereign bond yields mask some heterogeneous intra-euro area developments. Sovereign yield spreads widened in several countries (see Chart 6). This was especially evident in France, where increased political uncertainty surrounding the upcoming presidential election led to some volatility in sovereign yield spreads. The ten-year French yield spread to the risk-free overnight interest swap rate ended the review period around 20 basis points wider, after widening by up to 40 basis points during the review period. In countries with a lower rating, a similar widening of the spread was observed.

Chart 6

Euro area sovereign spreads vis-à-vis the euro area OIS rate

(percentages per annum)