Update on economic and monetary developments
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. Incoming data since the Governing Council’s meeting in early March confirm that the cyclical recovery of the euro area economy is becoming increasingly solid and that downside risks have further diminished.  At the same time, underlying inflation pressures continue to remain subdued and have yet to show a convincing upward trend. Moreover, the ongoing volatility in headline inflation underlines the need to look through transient developments in HICP inflation, which have no implication for the medium-term outlook for price stability.
Available indicators point to sustained global growth at the beginning of 2017, while the recovery in international trade has continued. The global recovery is broadening, with the improvement in growth being widespread across countries. International financial conditions have remained overall supportive, despite significant policy uncertainty. Global headline inflation has increased further, mainly driven by energy prices. However, oil prices have recently undergone some volatility.
Euro area financing conditions remain very favourable. Comparing developments between the Governing Council meetings of 9 March and 27 April, bond, equity and foreign exchange markets overall show only small movements.
Incoming data, notably survey results, suggest that the ongoing economic expansion will continue to firm and broaden. The pass-through of the monetary policy measures is supporting domestic demand and facilitates the ongoing deleveraging process. The recovery in investment continues to benefit from very favourable financing conditions and improvements in corporate profitability. Employment gains, which are also benefiting from past labour market reforms, are supporting real disposable income and private consumption. Moreover, the signs of a stronger global recovery and increasing global trade suggest that foreign demand should increasingly add to the overall resilience of the economic expansion in the euro area. However, economic growth continues to be dampened by a sluggish pace of implementation of structural reforms, in particular in product markets, and by remaining balance sheet adjustment needs in a number of sectors. The risks surrounding the euro area growth outlook, while moving towards a more balanced configuration, are still tilted to the downside and relate predominantly to global factors.
Inflation has been recovering from the very low levels seen in 2016, largely owing to higher energy price increases. After reaching 2.0% in February, euro area annual HICP inflation declined to 1.5% in March 2017. Measures of underlying inflation, however, have remained low and are expected to show only a gradually rising trend over the medium term, supported by the monetary policy measures, the expected continuing economic recovery and the corresponding gradual absorption of slack.
Broad money growth remained robust, while the recovery in loan growth to the private sector observed since the beginning of 2014 is proceeding. The euro area bank lending survey for the first quarter of 2017 indicates that net loan demand has increased and bank lending conditions have eased further across all loan categories. The pass-through of the monetary policy measures put in place since June 2014 thus continues to significantly support borrowing conditions for firms and households and credit flows across the euro area. Moreover, financing costs for euro area non-financial corporations are estimated to have remained favourable in the early months of 2017.
At its meeting on 27 April 2017, based on the regular economic and monetary analyses, the Governing Council decided to keep the key ECB interest rates unchanged. The Governing Council continues to expect the key ECB interest rates 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 the net asset purchases, at the new monthly pace of €60 billion, are intended to run 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 asset purchase programme.
Looking ahead, the Governing Council confirmed that a very substantial degree of monetary accommodation is needed for euro area inflation pressures to build up and support headline inflation in the medium term. If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the asset purchase programme in terms of size and/or duration.
Surveys point to sustained global growth in the first quarter of 2017. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area increased in March (see Chart 1), driven by a rise in the services index while the manufacturing PMI remained broadly unchanged at three-year highs. In quarterly terms, the PMI remained at about the same level in the first quarter of 2017 relative to the previous quarter, pointing to ongoing robust growth. Quarterly PMIs weakened in the United Kingdom and to a lesser extent in the United States, but picked up in Japan. Among emerging market economies (EMEs), quarterly PMIs decreased in China, but improved in Russia, India and Brazil – albeit remaining below the expansionary level.
Global composite output PMI
Sources: Markit and ECB calculations.
Note: The latest observations are for March 2017.
The recovery is broadening, with the improvement in growth being widespread across countries. Indeed, the dispersion of quarterly growth rates across countries has narrowed considerably in recent quarters. In particular, activity in commodity exporters has stabilised following the rebound in commodity prices, while temporary downturns caused by domestic factors in countries such as Turkey are also bottoming out.
Global financial conditions remain broadly supportive. Equity markets have moderated recently as investors had some concerns about the ability of the new US administration to follow through on policy pronouncements. Yet despite significant policy uncertainty, financial markets have been generally resilient, with risk aversion low. The Federal Reserve System increased its official interest rates at its March meeting. While other major central banks are expected to maintain an accommodative stance, markets have also been buoyed by expectations that monetary tightening in the United States will be gradual. In China, financial conditions have tightened for banks and bond yields have increased, but benchmark bank lending rates have remained unchanged. Financial conditions in most other EMEs have improved with financial markets rebounding and, following some weeks of outflows, capital has flowed back towards EMEs.
The recovery in global trade continued at the start of the year. Growth in global goods imports increased to 2.8% (in three-month-on-three-month terms) in February, the strongest figure in more than ten years (see Chart 2). The rise in momentum was mainly driven by EMEs, with particularly strong improvements in central and eastern Europe and Latin America. Leading indicators also confirm the positive trend. The global PMI for new export orders increased to 52.5 in the first quarter of 2017, pointing to a sustained recovery in global trade growth.
Global trade and surveys
(in three-month-on-three-month percentage (left-hand scale); diffusion index (right-hand scale))
Sources: Markit, CPB Netherlands Bureau for Economic Policy Analysis and ECB staff calculation.
Note: The latest observations are for February 2017 for global merchandise imports and March 2017 for PMIs.
Global inflation increased further in February, mainly driven by energy prices. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) reached 2.5% in February, a level not seen in almost five years. Excluding food and energy, OECD annual inflation remained unchanged at 1.9% compared with figures for January. Slowly diminishing spare capacity at the global level is expected to give some support to underlying inflation looking forward, while the current oil futures curve anticipates very stable oil prices, pointing to a very limited contribution from energy prices to inflation.
Since late last year when members of the Organization of the Petroleum Exporting Countries (OPEC) and 11 non-OPEC producer countries agreed to cut oil production, Brent crude oil prices have fluctuated in the range of USD 49 to USD 56 per barrel. While global oil production dropped in January as expected, in February oil supply in both OPEC and non-OPEC countries increased, raising concerns about whether the supply curtailment would be complied with. At the same time rising US crude oil inventories and shale oil supply further weighed negatively on oil prices, sending them back to USD 50 per barrel where they had stood at the end of November 2016. Since the beginning of April, prices have reverted to a mild positive trend owing to a new decline in US inventories and outages in Libya’s largest oilfield due to renewed geopolitical tensions. Expectations that the OPEC cut would be extended for the second half of 2017 have also recently been priced in. Non-oil commodity prices have decreased by around 5%, in US dollar terms, since early March. This has been driven largely by a substantial decline in the price of iron ore, due to high stocks at Chinese ports and expectations of a moderation in Chinese steel demand and, to a lesser extent, due to a decline in food prices. Other non-ferrous metal prices remained broadly stable.
The outlook for economic activity in the United States remains broadly robust. Real GDP expanded at an annualised rate of 2.1% in the fourth quarter of 2016, supported primarily by consumer spending and private investment. Survey and hard data have diverged at the start of 2017, with consumer and business sentiment continuing to be robust, while industrial production, core capital goods orders and consumer spending are softening. However, some of the factors holding back consumption are temporary, including exceptionally warm weather weighing on energy consumption, and delays in tax refunds. At the same time, labour market conditions continued tightening in March, with the unemployment rate reaching 4.5% (below the Federal Open Market Committee’s estimate of full employment) and annual growth in average hourly earnings at 2.7%. In March annual headline consumer price index (CPI) inflation in the United States decreased to 2.4%, mostly stemming from a decline in the energy component. The main components of core inflation also moderated, leading to a fall in CPI excluding food and energy to 2.0%.
Economic growth in Japan remains modest. Real GDP increased by 0.3% quarter on quarter in the fourth quarter of 2016, with both domestic demand growth and net trade remaining subdued. After some weakness in January, industrial production and real exports have rebounded and remain on average above last year’s levels for the same period. Moreover data on private consumption point to some tentative signs of a recovery, supported by developments in the labour market. However, the tightening in the labour market, with the unemployment rate at its lowest level since 1994, has not led to an acceleration in wage growth. Headline CPI inflation increased to 0.4% in January year on year. At the same time, annual growth in CPI excluding fresh food and energy – the Bank of Japan’s preferred measure of core inflation – also strengthened somewhat, to 0.2%.
Following robust growth in the UK economy last year, recent indicators point to a softer start into 2017. In the final quarter of 2016, real GDP increased by 0.7% quarter on quarter. However, recent indicators overall suggest that the pace of economic expansion softened at the start of this year. In particular, there are signs that rising inflation is curtailing real incomes and private consumption. The pick-up in inflation over recent months has been driven largely by energy prices and the depreciation of the pound sterling since the UK referendum on EU membership. In March 2017 annual CPI inflation stood at 2.3%. On 29 March 2017 the UK government gave formal notice of its intention to withdraw from the European Union, paving the way for EU-UK negotiations in accordance with Article 50 of the Treaties.
Economic growth in the Chinese economy stabilised. Real GDP grew at 6.9%, in year-on-year terms, in the first quarter of 2017, slightly higher than in the previous quarter. Growth was mainly driven by consumption, while the contribution of gross fixed capital formation was the lowest since early 2015. However, overall momentum in the first quarter was weaker than in the last quarter of 2016. It was also weaker than what some available indicators suggested, in particular for investment and construction, which could reflect a residual seasonality affecting the estimate for the first quarter. Annual CPI inflation fell to 0.8% in February, from 2.5% in January, as food and tourism services prices fell after the Chinese New Year holiday. Inflation excluding food and energy decreased to 1.8% from 2.2%. Meanwhile, annual producer price inflation rose to 7.8%, which is attributed to rising ferrous metal and energy prices. Reductions in overcapacity in heavy industry have pushed up raw material prices but this is likely to be temporary.
Overall, euro area government bond yields have slightly declined since early March. The slight decline during the period under review (9 March to 26 April 2017) has taken place in the context of heightened political uncertainty surrounding the French presidential elections. As a result, a phase of declining yields between late March and the day before the first-round results of the French elections were known was partially offset by rising yields in the aftermath of the vote. Overall, the euro area ten-year overnight index swap (OIS) yield declined by 5 basis points while sovereign bond yields decreased on average by around 15 basis points. Across countries, the declines ranged from a few basis points to around 70 points, while some marginal increases were observed in Italy and the Netherlands. Spreads vis-à-vis the rate on German ten-year bonds overall remained unchanged or decreased slightly in most countries, with the exception of Greece and Portugal (where the declines reached around 70 basis points) and Italy and the Netherlands (where spreads rose marginally).
Selected euro area and US equity price indices
(1 January 2016 = 100)
Source: Thomson Reuters.
Notes: Daily data. The black vertical line refers to the start of the review period (9 March 2017). The latest observation is for 26 April 2017.
Euro area equity prices have increased since early March. At the end of the period under review the equity prices of euro area non-financial corporations (NFCs) were around 5% higher than at the beginning, while prices rose by almost 7% for financial corporations. Overall, the recent positive developments in the euro area stock market have led equity prices of banks to now stand around 70% higher than the lows recorded in the aftermath of the United Kingdom’s referendum on EU membership in June 2016 (see Chart 3). As has been the case for bonds, political uncertainty has also affected developments in the euro area equity market: euro area equities mostly moved sideways ahead of the outcome of the French presidential elections only to then rise significantly. Since early March equity prices of NFCs in the United States and the United Kingdom have risen significantly less than in the euro area, while they declined marginally in Japan. The equity prices of financial corporations underperformed relative to NFCs in all three economic areas. Market expectations of equity price volatility increased significantly in the euro area to around 23% ahead of the French elections, but reverted to the levels prevailing in early March, i.e. around 14%, in the aftermath. In the United States, by contrast, market-based expectations of equity price volatility remained broadly stable from early March.
Spreads on bonds issued by NFCs declined marginally during the period under review. On 26 April, investment grade NFC bond spreads (on average for rating classes AAA, AA, A and BBB) were 4 basis points lower than in early March and still around 25 basis points lower than in March 2016, when the Governing Council announced the launch of the corporate sector purchase programme (CSPP). Spreads on non-investment grade NFC and financial sector debt (which is ineligible for purchase under the CSPP) also declined over the same period, by 10 and 4 basis points respectively.
In foreign exchange markets, the euro recorded a small depreciation in trade‑weighted terms. In bilateral terms, from 9 March, the euro appreciated by 3.2% against the US dollar and by 2.9% against the Chinese renminbi. Such developments were more than offset by a weakening of the euro vis-à-vis the currencies of other principal trading partners of the euro area. In particular, the euro depreciated against the pound sterling (by 2%) and against the currencies of most other non-euro area EU Member States. In the case of the Czech koruna, the euro weakened against it slightly (by 0.3%) following the discontinuation of the koruna’s exchange rate floor (see Chart 4).
Changes in the exchange rate of the euro vis-à-vis selected currencies
Note: 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.
The euro overnight index average (EONIA) remained stable during the review period, at around -35 basis points. Excess liquidity increased by around €243 billion, to approximately €1,608 billion. The increase was primarily attributable to the final targeted longer-term refinancing operation in the second series (TLTRO-II), which resulted in a net injection of liquidity of around €200 billion (see Box 5 in this issue of the Economic Bulletin for more details on TLTROs). In addition, the purchases under the expanded asset purchase programme (APP) continued to contribute to rising excess liquidity.
The EONIA forward curve has shifted downwards by around 10 basis points on average across maturities. An initial upward movement of the curve, which lasted until around mid-March, was more than reversed in the remainder of the review period. Overall, the EONIA forward curve for maturities above eight years moved downwards by around 15 basis points, while the three to seven-year segment declined by some 10 basis points. Forward rates declined only more marginally for shorter maturities. The curve remains below zero for maturities prior to early 2020.
The domestic demand-driven economic expansion in the euro area is firming and broadening. Real GDP increased by 0.5%, quarter on quarter, in the fourth quarter of 2016 (see Chart 5), on the back of positive contributions from domestic demand and, to a lesser extent, changes in inventories. At the same time, net trade provided a strong negative contribution to GDP growth, as import growth significantly outpaced the rise in exports. The latest economic indicators, both hard data and survey results, remain buoyant and point to ongoing growth in the first half of 2017, at around the same rate as that observed in the fourth quarter of last year.
Euro area real GDP, the Economic Sentiment Indicator (ESI) and the composite output Purchasing Managers’ Index (PMI)
(quarter-on-quarter percentage growth; index; diffusion index)
Sources: Eurostat, European Commission, Markit and ECB.
Notes: The ESI is normalised with the mean and standard deviation of the PMI. The latest observations are for the fourth quarter of 2016 for real GDP, March 2017 for the ESI and April 2017 for the PMI.
Consumer spending rose again in the fourth quarter of 2016, thus continuing to be an important driver of the ongoing recovery. Quarterly private consumption growth increased further to 0.5%. This improvement in growth took place despite a rise in the euro price of oil of almost 15% between the third and fourth quarter of last year. On an annual basis, consumption rose by 1.9% in the fourth quarter, after 1.8% in the third quarter. This slight increase was in contrast to a sharp slowdown in the growth of households’ real disposable income, to 1.1%, year on year, from 1.6% in the third quarter. This decline, in turn, mirrored the increase in annual inflation, as measured by the private consumption deflator, between the third and fourth quarter. It should be borne in mind, however, that income growth, despite the latest decline, remains relatively high by historical standards. Indeed, consumer spending during the ongoing recovery has been benefiting from rising real labour income for households, which has primarily reflected rising employment and lower oil prices. The slightly higher consumption growth, alongside falling real income growth, between the third and fourth quarter resulted in a fall in the household saving rate.
Euro area labour markets continue to improve, thus supporting income and spending. Employment rose further, by 0.3%, quarter on quarter, in the fourth quarter of 2016, resulting in an annual increase of 1.2%. As a result, employment currently stands 3.4% above the last trough in the second quarter of 2013. However, compared with the pre-crisis peak in the first quarter of 2008, employment is still down by almost half a percent. The unemployment rate in the euro area edged down to 9.5% in February 2017, i.e. 2.6 percentage points below its post-crisis peak in April 2013 (see Chart 6). This decline was broad-based across age and gender groups (see also Box 2). However, the degree of underutilisation of labour remains high and considerably above that suggested by the unemployment rate (see Box 3). Survey information points to continued improvements in labour markets in the period ahead.
Euro area employment, PMI employment expectations and unemployment
(quarter-on-quarter percentage changes; diffusion index; percentage of labour force)
Sources: Eurostat, Markit and ECB calculations.
Notes: The PMI is expressed as a deviation from 50 divided by 10. The latest observations are for the fourth quarter of 2016 for employment, April 2017 for the PMI and February 2017 for unemployment.
Consumption growth is expected to remain robust. After having improved in the fourth quarter of 2016, consumer confidence increased again in the first quarter. As a result, consumer sentiment stands well above its long-term average and close to its pre-crisis peak level in 2007. Moreover, data on retail trade (up to February 2017) and new passenger car registrations (for the full first quarter) are in line with positive growth in consumer spending in the first quarter of 2017, at a similar pace to that observed in the fourth quarter. Moreover, further employment growth, as suggested by the latest survey indicators, should also continue to support aggregate income and consumer spending. Finally, households’ net worth relative to disposable income continues to rise, owing largely to valuation gains on real estate holdings. This development should add support to overall consumption growth.
Investment growth rebounded strongly in the fourth quarter, after the weak outcome in the third quarter. Total investment rose by 3.3%, quarter on quarter, in the fourth quarter of 2016, reflecting a strong rise in non-construction investment. The 6.4% rise in non-construction investment was due to a sharp increase in investment in intellectual property products, in turn reflecting the transaction of assets by a small number of large economic operators in Ireland. By contrast, investment in machinery and equipment contracted slightly in the fourth quarter. Meanwhile, the small increase in construction investment, of 0.1%, quarter on quarter, reflected a rise in investment in homes, which was partly offset by a decline in investment in other buildings and structures.
Incoming information suggests that both business investment and construction investment continued to rise in the first quarter of 2017. Continued positive growth in business investment is indicated by the average level of industrial production of capital goods in January and February, which was 0.2% up on that in the fourth quarter of 2016. Moreover, confidence in the capital goods sector was, on average, higher in the first quarter than in the previous quarter, and the assessment of order books in the capital goods sector improved both overall and in terms of orders from abroad, alongside the observed gradual improvement of the external environment. With regard to construction investment, monthly construction production data point to positive growth in the first quarter of 2017. Furthermore, survey indicators on the demand situation and the assessment of order books in the sector, as well as building permits, are still in line with positive underlying dynamics in the short term.
The recovery in investment is expected to continue in the medium term. Business investment is expected to be supported by domestic and external demand and favourable financing conditions, in the context of the accommodative monetary policy. Improving corporate profits should also support investment. As regards construction investment, factors such as households’ rising disposable income and improving lending conditions should underpin demand in the sector. Downside risks to the outlook for business investment relate to remaining deleveraging needs in some countries.
Monthly trade data point to a continued rise in euro area exports in the near term. Total euro area exports rose by 1.8% in the fourth quarter, mainly on account of a rebound in goods exports, supported by a weaker effective exchange rate of the euro and a gradual rebound in global trade. Monthly trade in goods outcomes for January and February suggest that extra-euro area exports continued to firm in the first quarter of 2017. The export growth momentum (in three-month-on-three-month percentage changes) seems to be driven by demand mainly from Asia (including China) and improvements in Russia as well as the United States.
Euro area exports are expected to rebound as global trade continues to firm. Survey indicators signal improvements in foreign demand, and new export orders have risen. In addition, the effective exchange rate of the euro depreciated in the first four months of 2017 and could spur competiveness gains for euro area exporters. However, any emergence of protectionist tendencies around the world could pose downside risks to the outlook for foreign demand and hence euro area exports in the longer term.
Overall, the latest economic indicators are, on balance, consistent with ongoing real GDP growth in the first and second quarters of 2017, at around the same rate as in the fourth quarter of last year. Industrial production (excluding construction) displayed a small decline in February 2017 following a rise of the same magnitude in the previous month. As a result, average production over these two months stood broadly at the same level as in the final quarter of 2016, when production rose by 0.9% on a quarterly basis. More timely survey data are also in line with continued positive growth dynamics in the near term. The composite output Purchasing Managers’ Index (PMI) averaged 55.6 in the first quarter of 2017, compared with 53.8 in the fourth quarter, before rising to 56.7 in April from 56.4 in March (see Chart 5). At the same time, the European Commission’s Economic Sentiment Indicator (ESI) rose to 107.9 in the first quarter from 106.9 in the fourth quarter. Consequently, both the ESI and the PMI, which remain above their respective long-term averages, are approaching their recent peaks at the beginning of 2011.
Looking ahead, the ongoing economic expansion is expected to continue to firm and broaden. The pass-through of the monetary policy measures is supporting domestic demand and facilitates the ongoing deleveraging process. The recovery in investment continues to benefit from very favourable financing conditions and improvements in corporate profitability. Employment gains, which are also benefiting from past labour market reforms, are supporting real disposable income and private consumption. Moreover, the signs of a stronger global recovery and increasing global trade suggest that foreign demand should increasingly add to the overall resilience of the economic expansion in the euro area. However, economic growth continues to be dampened by a sluggish pace of implementation of structural reforms, in particular in product markets, and by remaining balance sheet adjustment needs in a number of sectors. The risks surrounding the euro area growth outlook, while moving towards a more balanced configuration, are still tilted to the downside and relate predominantly to global factors. The results of the latest round of the ECB’s Survey of Professional Forecasters, conducted in early April, show that private sector GDP growth forecasts were revised upwards for 2017 and 2018 in comparison with the previous round conducted in early January.
Prices and costs
Headline inflation fell back in March. After reaching 2.0% in February, headline inflation declined to 1.5% in March (see Chart 7). The decline was driven in particular by lower inflation rates for the volatile components energy and unprocessed food, but also by lower HICP inflation excluding food and energy.
Contributions of components to euro area headline HICP inflation
(annual percentage changes; percentage point contributions)
Sources: Eurostat and ECB calculations.
Note: The latest observations are for March 2017.
Measures of underlying inflation have remained subdued. The annual rate of HICP inflation excluding food and energy declined to 0.7% in March 2017 from 0.9% in February – the lowest level over the last two years. The decline resulted to a large extent from the deceleration in the very volatile travel-related components of services. This most likely reflected mainly price effects linked to the timing of the Easter holidays (with Easter being in April this year but in March last year), which are thus likely to be of a more temporary nature. HICP inflation excluding food and energy has remained well below its long-term average of 1.4%. Furthermore, most alternative measures also do not indicate a pick-up in underlying inflationary pressures. This may reflect in part the lagged downward indirect effects of past low oil prices but also, more fundamentally, continued weak domestic cost pressures.
Some pipeline pressures have built up at the early stages of the production and pricing chain. At the early stages of the pricing chain, above-average global producer price inflation (excluding oil) and strong growth in import prices for intermediate goods point to a build-up of pipeline price pressures. Intermediate goods are also the main driver of recent increases in producer price inflation for total industry (excluding construction and energy) in the euro area, which rose to 2.1% in February 2017 from 1.5% in January. Further along the pricing chain some upward pressure is visible in the annual inflation for import prices of non-food consumer goods, which continued their marked pick-up since November 2016 and rose further from -0.1% in January to 0.6% in February. However, domestic producer price inflation for non-food consumer goods remained largely flat at a subdued level, recording 0.2% in February, and so has not as yet provided support for non-energy industrial goods inflation (see also the discussion in Box 4 entitled “What can recent developments in producer prices tell us about pipeline pressures?”).
Wage growth in the euro area has been picking up slightly, but remains low. Annual growth in compensation per employee rose from 1.3% in the third quarter of 2016 to 1.5% in the fourth quarter, but continues to stand well below its long-term average (since 1999) of 2.1%. Factors that may have been weighing on wage growth include still significant slack in the labour market, weak productivity growth and the ongoing impact of labour market reforms implemented in some countries during the crisis. Additionally, the low inflation environment over the last years may be still contributing to lower wage growth through backward-looking formal and informal indexation mechanisms.
Market and survey-based measures of inflation expectations
(annual percentage changes)
Sources: Thomson Reuters and ECB calculations.
Note: The market-based measures of inflation expectations are derived from HICPx (the euro area HICP excluding tobacco) zero coupon inflation-linked swaps.
Longer-term market-based inflation expectations have declined somewhat, while survey-based measures remained stable. Since early March market-based measures of inflation expectations have declined across all maturities (see Chart 8). The five-year forward inflation rate five years ahead declined to around 1.6%, which is around 10 basis points lower than the level observed in early March 2017. By contrast, the survey-based measures for long-term inflation expectations for the euro area from the April 2017 ECB Survey of Professional Forecasters (SPF) remained stable at 1.8%.
Residential property prices in the euro area accelerated further. According to the ECB’s residential property price indicator, prices for houses and flats in the euro area increased by 3.8% on a year-on-year basis in the fourth quarter of 2016, up from 3.4% in the third quarter, which points to a strengthening and broadening of the house price cycle.
Money and credit
Broad money growth remained robust. The annual growth rate of M3 remained broadly stable in February 2017 (at 4.7%, after 4.8% in January), hovering around a rate of 5.0% since mid-2015 (see Chart 9). The low opportunity cost of holding liquid deposits in an environment of very low interest rates and the impact of the ECB’s monetary policy measures continued to support M3 growth. Annual M1 growth was again the main contributor to M3 growth. Its pace remained stable in February (at 8.4%).
M3 and its counterparts
(annual percentage changes, percentage point contributions)
Notes: “Domestic counterparts other than credit to general government” includes MFIs’ longer-term financial liabilities (including capital and reserves), MFI credit to the private sector and other counterparts. The latest observation is for February 2017.
Broad money growth was again driven by domestic sources of money creation. Purchases of debt securities in the context of the public sector purchase programme (PSPP) continued to have a considerable positive impact on M3 growth (see the orange bars in Chart 9). By contrast, the contribution of credit to general government from monetary financial institutions (MFIs) excluding the Eurosystem remained negative (see the green bars in Chart 9).
Domestic counterparts other than credit to general government also exerted a positive impact on M3 growth (see the blue bars in Chart 9). On the one hand, this reflects the gradual recovery in the growth of credit to the private sector. On the other hand, the significantly negative annual rate of change in MFIs’ longer-term financial liabilities (excluding capital and reserves) continued to support M3 growth. This is partly explained by the flatness of the yield curve, which is linked to the ECB’s monetary policy measures and has made it less attractive for investors to hold long-term deposits and bank bonds. The availability of the targeted longer-term refinancing operations (TLTROs) as an alternative to longer-term market-based bank funding also played a role.
The MFI sector’s net external asset position continued to exert downward pressure on annual M3 growth (see the yellow bars in Chart 9). This development reflects ongoing capital outflows from the euro area. PSPP-related sales of euro area government bonds by non-residents make an important contribution to this trend.
The recovery in loan growth is proceeding. The annual growth rate of MFI loans to the private sector (adjusted for sales, securitisation and notional cash pooling) was broadly stable in February (see Chart 10). Across sectors, the annual growth of loans to non-financial corporations (NFCs) decreased somewhat, while that of loans to households remained stable. The significant decrease in bank lending rates seen across the euro area since summer 2014 (owing notably to the ECB’s non-standard monetary policy measures) and overall improvements in the supply of, and demand for, bank loans have supported the recovery in loan growth. In addition, banks have made progress in consolidating their balance sheets, although the level of non-performing loans remains high in some countries and may constrain bank lending.
M3 and loans to the private sector
(annual rate of growth and annualised six-month growth rate)
Notes: Loans are adjusted for loan sales, securitisation and notional cash pooling. The latest observation is for February 2017.
The April 2017 euro area bank lending survey suggests that loan growth continued to be supported by eased lending conditions and increasing demand across all loan categories. In the first quarter of 2017, credit standards for loans to enterprises and for loans to households for house purchase eased slightly. The ECB’s expanded asset purchase programme (APP) has had an easing impact on credit terms and conditions across all loan categories. The net easing impact was stronger for terms and conditions than for credit standards. Euro area banks reported that the APP has contributed to an improvement of their liquidity position and their market financing conditions. They have mainly used the liquidity obtained from the APP to grant loans. Furthermore, the ECB’s negative deposit facility rate was said to be having a positive effect on lending volumes, but weighing on banks’ net interest income. Banks also reported increasing net loan demand from households and NFCs. This increase was driven by a variety of factors, in particular the low general level of interest rates, merger and acquisition activity and favourable housing market prospects.
The decline in bank lending rates, which started in early 2014, has flattened at the beginning of 2017 (see Chart 11). Between May 2014 and February 2017, composite lending rates on loans to euro area NFCs and households fell by 117 and 106 basis points, respectively. Composite lending rates for NFCs and households have decreased by significantly more than market reference rates since the announcement of the ECB’s credit easing measures in June 2014. The reduction in bank lending rates on NFC loans was especially strong in vulnerable countries, thereby contributing to mitigating previous asymmetries in monetary policy transmission across countries. 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 narrowed considerably. This indicates that small and medium-sized enterprises have generally been benefiting to a greater extent from the decline in bank lending rates than large companies.
Composite bank lending rates for NFCs and households
(percentages per annum)
Notes: Composite bank lending rates are calculated by aggregating short and long-term rates using a 24-month moving average of new business volumes. The latest observation is for February 2017.
The net issuance of debt securities by NFCs remained robust in the first quarter of 2017. The latest ECB data show that the net issuance of debt securities by euro area NFCs increased again in January and February 2017, after declining in December 2016 mainly due to seasonal factors. Issuance activity continued to be supported by the ECB’s purchases of non-bank investment-grade corporate bonds, among other factors. Preliminary data suggest that issuance remained robust in March. The net issuance of listed shares has been modest in the first months of 2017.
Financing costs for euro area NFCs are estimated to have remained favourable in the first months of 2017. In the first quarter of 2017, the overall nominal cost of external financing for NFCs is estimated to have barely changed compared with December 2016. The level observed in March was only slightly above the historical low level recorded last summer. However, the cost of equity financing remains at high levels compared with the cost of debt financing, reflecting a relatively high equity risk premium. By contrast, the cost of debt financing has continued to decline in recent months, thus reaching a new historical low.
The ECB’s asset purchase programme and TARGET balances: monetary policy implementation and beyond
This box analyses the increase in TARGET balances since the start of the asset purchase programme (APP) and explains why the current dynamics differ from those observed during previous episodes of rising balances.  TARGET balances are the claims and liabilities of euro area national central banks (NCBs) vis-à-vis the ECB that result from cross-border payments settled in central bank money. Net payment inflows into a country increase the TARGET claim (or reduce the TARGET liability) of its NCB while net payment outflows have the opposite effect. The total TARGET balance, which is the sum of all positive balances, is only affected when central bank money flows between countries with positive and negative balances. Cross-border flows of central bank money, as reflected in changes in TARGET balances, are recorded in the balance of payments of euro area countries. According to balance of payments accounting, these flows must be mirrored in other components of the balance of payments, such as the current account or portfolio investment flows.
Sizeable TARGET balances can be a consequence of the injection of large amounts of excess liquidity by the euro area’s decentralised central banking system. TARGET balances emerge when the central bank reserves created in one jurisdiction flow to another. During the sovereign debt crisis, there was a demand-driven increase in excess liquidity as banks substituted Eurosystem funding for market-based funding that had dried up. Although the initial provision of liquidity via refinancing operations was TARGET-neutral, TARGET balances increased as this liquidity subsequently flowed from vulnerable to less-vulnerable countries in the context of severe market stress. Since the start of the expanded APP, however, the renewed increase in excess liquidity has been predominantly supply-driven, resulting from asset purchases by NCBs and the ECB rather than stress-related recourse to refinancing operations. The APP – and in particular the public sector purchase programme (PSPP) – gives rise to increasing TARGET balances (see Chart A) by inducing large cross-border liquidity flows. These flows arise (i) during APP implementation and (ii) via further portfolio rebalancing.
Sum of TARGET balances for the three NCBs with the largest claims and the three with the largest liabilities
(EUR billions; end-of-month data)
Notes: The three countries with the largest TARGET claims at the end of March 2017 were Germany, Luxembourg and the Netherlands, while the three with the largest TARGET liabilities were Italy, Spain and Portugal (although the ECB’s liability is actually greater than that of Portugal). The vertical black lines mark the commencement of purchases under the APP and the PSPP in October 2014 and March 2015, respectively. The latest data are for March 2017.
The financial structure of the euro area contributes to the current increase in TARGET balances because cross-border payments are an inherent feature of decentralised APP implementation in an integrated market. APP implementation is distinct from that of refinancing operations because it can entail immediate cross-border payments, as purchases are not limited by national borders. In fact, around 80% of APP purchases by volume have involved non-domestic counterparties, while around 50% have involved counterparties resident outside the euro area, many of which are concentred in the United Kingdom. The latter have historically accessed TARGET2 via major euro area financial centres, particularly Germany and, to a lesser extent, the Netherlands. The main financial centres in the euro area have always been located in countries which, during the sovereign debt crisis, came to be viewed as less vulnerable. The settlement of APP transactions is therefore associated with structural cross-border flows to these locations.
The rise in the total TARGET balance has followed the upward path implied by cross-border payments for APP transactions, suggesting that other financial flows did not further increase the balance after the implementation of the APP. Chart B shows how the total TARGET balance has actually evolved alongside a simulated balance illustrating how it would have evolved if the only cross-border payments in the system had been those stemming from APP implementation. The actual balance is currently below the simulated balance, indicating that subsequent cross-border liquidity flows are not giving rise to additional increases in the total TARGET balance; it instead suggests that there are some net cross-border liquidity flows back to countries with TARGET liabilities from those with claims.
Total TARGET balance since the launch of the PSPP and a simulated balance
(EUR billions; weekly data)
Sources: ECB, TARGET2 and ECB staff calculations.
Notes: The simulated TARGET balance is calculated using APP transaction data and information on the location of the TARGET accounts of APP counterparties (the ECB’s balance is treated separately from balances of non-euro area countries). The simulated balance shows how the total TARGET balance would have evolved since March 2015 if the only cross-border payments in the system had been the liquidity flows from central banks to counterparties’ TARGET2 accounts resulting from APP purchases. The latest data are for March 2017.
Payments related to subsequent portfolio rebalancing are also affected by the financial structure and keep TARGET balances elevated. Since the launch of the APP, there has been a broad-based rebalancing towards non-euro area debt securities in the euro area as a whole which has been driven to a significant extent by the persistently negative interest rate differentials between euro area bonds and bonds issued by other advanced economies. Euro area residents’ net purchases of non-euro area debt securities in this period have consisted almost exclusively of debt securities issued by other advanced economies, in particular the United States. Such international portfolio rebalancing usually takes place through actors located in major euro area financial centres, thereby contributing to the accumulation of reserves in particular locations and to the persistence of TARGET balances. This mechanism is evident in the net external assets of a country’s MFIs, which mirror the transactions of the non-banking sector with the rest of the world (see Chart C) and the way in which the associated payment flows are channelled (see Chart D). A breakdown of MFIs’ net external assets for the largest TARGET-liability countries shows that the payment flows associated with international portfolio rebalancing are mainly channelled via TARGET.
Monetary presentation of the balance of payments for the countries with the largest TARGET liabilities
(EUR billions; 12-month flows)