Economic and monetary developments

Overview

At its monetary policy meeting on 8 June 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 information that has become available since the previous monetary policy meeting in late April confirms a stronger momentum in the euro area economy, which is projected to expand at a somewhat faster pace than previously expected. The Governing Council considers that the risks to the growth outlook are now broadly balanced. Against this background, very adverse scenarios for the outlook for price stability have become increasingly unlikely to materialise, in particular as deflation risks have largely vanished. Hence, the Governing Council decided to drop the reference to lower interest rates from its forward guidance on policy rates. At the same time, the economic expansion has yet to translate into stronger inflation dynamics. So far, measures of underlying inflation continue to remain subdued and have yet to show a convincing upward trend. Therefore, the very substantial degree of monetary accommodation remains appropriate.

Economic and monetary assessment at the time of the Governing Council meeting of 8 June 2017

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. This is evident in continued very low bank interest rates. Likewise, the pass-through of the monetary policy measures put in place since June 2014 continues to significantly support borrowing conditions for firms and households, access to financing, notably for small and medium-sized enterprises, and, hence, credit flows across the euro area. Broad money continues to expand at a robust pace, while the recovery in loan growth to the private sector observed since the beginning of 2014 is proceeding.

The ongoing economic expansion in the euro area is increasingly resilient and has broadened across sectors and countries. Euro area real GDP increased by 0.6%, quarter on quarter, in the first quarter of 2017, after 0.5% in the last quarter of 2016. Short-term indicators such as surveys continue to point to robust growth momentum in the near term. The pass-through of the ECB’s monetary policy measures has also facilitated the deleveraging process and should continue to support domestic demand. In particular, 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.

Euro area activity is further supported by a sustained global recovery. Global trade growth has increased significantly in recent months, benefiting from, among other factors, the recoveries in emerging market economies. However, euro area economic growth prospects continue 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, notwithstanding ongoing improvements.

The June 2017 Eurosystem staff macroeconomic projections for the euro area, finalised in late May, which are conditional on the full implementation of all ECB monetary policy measures, foresee annual real GDP increasing by 1.9% in 2017, by 1.8% in 2018 and by 1.7% in 2019. Compared with the March 2017 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised upwards over the projection horizon. The risks surrounding the euro area growth outlook are considered to be broadly balanced. On the one hand, the current positive cyclical momentum increases the chances of a stronger than expected economic upswing. On the other hand, downside risks relating to predominantly global factors continue to exist.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in May, following 1.9% in April and 1.5% in March. As expected, the recent volatility in inflation rates was mainly due to energy prices and temporary increases in services prices over the Easter period. Following the recent fall in oil prices, global headline inflation has stabilised. Looking ahead, on the basis of current futures prices for oil, headline inflation in the euro area is likely to remain around recent levels in the coming months.

Measures of underlying inflation have remained low and have yet to show convincing signs of a pick-up, as unutilised resources are still weighing on domestic price and wage formation. Underlying inflation is expected to rise only gradually over the medium term, supported by the ECB’s monetary policy measures, the continuing economic expansion and the corresponding gradual absorption of economic slack.

The June 2017 Eurosystem staff macroeconomic projections for the euro area foresee annual HICP inflation at 1.5% in 2017, 1.3% in 2018 and 1.6% in 2019. By comparison with the March 2017 ECB staff macroeconomic projections, the outlook for headline HICP inflation has been revised downwards, mainly reflecting lower oil prices.

The euro area budget deficit is projected to fall further over the projection horizon (2017-19), mainly as a result of improving cyclical conditions and decreasing interest payments. The aggregate fiscal stance for the euro area is projected to be broadly neutral over the period 2017-19. The euro area government debt-to-GDP ratio, although still high, is projected to continue to decline. Countries with high levels of public debt would benefit from additional consolidation efforts to set their debt-to-GDP ratio firmly on a downward path.


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%. The Governing Council decided to keep the key ECB interest rates unchanged and expects them to remain at their present 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 under the asset purchase programme (APP), at the current 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 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 APP in terms of size and/or duration.


External environment

A temporary dip in global GDP growth in the first quarter of 2017 notwithstanding, global activity growth remained sustained in the first months of the year. Momentum in global trade improved markedly, driven mostly by increased trade from emerging market economies. Global headline inflation has stabilised in recent months, as the effect of past commodity price increases has diminished. However, oil prices have declined in recent weeks, which should dampen global inflation rates in the short term.

Global economic activity and trade

A temporary dip in global GDP growth in the first quarter of 2017 notwithstanding, global activity growth remained sustained at the start of year. In the United States, GDP growth fell to 0.3% quarter-on-quarter, mainly reflecting weaker consumer spending and a large reduction in inventory investment spending. In the United Kingdom, GDP growth also declined, as higher inflation following the depreciation of the pound sterling squeezed real incomes and household spending. In China, the decline in GDP growth to 1.3% quarter-on-quarter was somewhat at odds with more upbeat short-term indicators. On the other hand, GDP growth rebounded sharply in both Russia and Brazil as they exited recession, while, in India, activity growth recovered amid the waning effects of demonetisation.

Survey indicators suggest that global growth will rebound in the near term. Excluding the euro area, the global composite Purchasing Managers’ Index (PMI) was largely unchanged in May, remaining slightly below the long-run average level and signalling a continued moderate expansion in global activity (Chart 1). Sentiment surveys have been upbeat, with consumer confidence in OECD countries rising towards pre-crisis levels and business confidence also improving.

Chart 1

Global composite output PMI

(diffusion index)

48 50 52 54 56 58 60 2011 2012 2013 2014 2015 2016 2017 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 May 2017. “Long-term average” refers to the period from January 1999 to May 2017.

Financial markets are consistent with expectations of improving near-term global growth. Having risen sharply after the US election, global equity markets and long-term bond yields declined in April and early May amid investor doubts about the ability of the new US administration to follow through on policy promises. However, global markets rebounded sharply after the French presidential election. Overall, financial markets have generally been resilient and risk aversion low. Financial conditions in emerging market economies (EMEs) are also benefitting from expectations of a brighter global growth outlook and capital flows towards EMEs have revived.

Monetary policies remain accommodative. While other major central banks are expected to maintain their accommodative stance, markets continue to expect monetary tightening in the United States to be very gradual. In China, financial conditions have tightened as the People’s Bank of China increased interbank rates in an effort to curb the riskier lending of small banks and non-bank institutions. However, benchmark bank lending rates for non-financial firms have remained unchanged, suggesting that, so far, the impact on the broader economy is modest.

Looking ahead, after a rebound in the near term, global economic activity is expected to accelerate gradually. The outlook among advanced economies entails a modest expansion, underpinned by continued monetary and fiscal policy support, as the cyclical recovery continues and output gaps gradually close. Among EMEs, the outlook is supported by resilient growth in China and India, while activity is expected to strengthen among commodity exporters. The recovery of these latter economies is the main driver of the projected increase in global GDP growth in the next two years. Nonetheless, the pace of global expansion will remain below pre-crisis rates, which is consistent with estimates suggesting that the growth potential has declined across most advanced and emerging economies in recent years.

In the United States, activity is expected to strengthen. After the weak first quarter, a strong rebound is expected in the remainder of 2017, as consumer and business sentiment remain high and improved labour market conditions gradually feed into higher wage growth. A strong recovery in investment in the energy sector is also expected to support the economy.

In the United Kingdom, real GDP growth is expected to remain relatively muted in the near term. Although the depreciation of the pound sterling is likely to support exports, the increase in inflation is expected to weigh on household incomes and private consumption. Heightened uncertainty about the United Kingdom’s future trade arrangements are also anticipated to weigh on investment.

In Japan, accommodative policies are expected to continue to support expansion. Accommodative monetary policy, looser financial conditions and the fiscal stimulus programme should support domestic demand, while exports are expected to gradually recover as external demand improves. However, despite robust job creation, wage increases have remained modest, dampening private consumption.

In China, activity is expected to continue expanding at a robust pace, supported by resilient consumption and the buoyant housing market. However, an increased focus on containing financial stability risks has led to tighter financial conditions since late 2016. In the medium term, growth is anticipated to remain on a gradual downward trend, consistent with the authorities’ desire to rebalance the economy.

Central and eastern European countries are expected to benefit from strong consumption and investment, the latter supported by EU structural funds. Although inflation is expected to gradually increase, reflecting fading effects of energy price falls, real disposable income is also expected to strengthen as the labour market tightens and wage pressures increase.

The large commodity exporters are expected to continue their recovery after deep recessions. In Russia, the rebound in the oil price since last year, coupled with a more accommodative monetary policy, is expected to support growth, although domestic demand remains fragile amid high uncertainty, low real wages and depressed confidence. Stabilising business confidence, improving terms of trade and loosening financial conditions are anticipated to benefit activity in Brazil. At the same time, recurring political uncertainties and fiscal consolidation needs continue to weigh on the medium-term outlook.

Momentum in global trade improved markedly at the end of last year and in early 2017. The volume of global goods imports increased by 1.8% quarter-on-quarter in the first quarter of 2017 (Chart 2). The recovery in global trade during the second half of 2016 and early 2017 has been driven mostly by an improvement in EMEs, with trade in emerging Asia benefiting from Chinese investment following a policy stimulus. Leading indicators point to continued robust trade prospects in the near term, with the global PMI for new export orders at 52.3 in May. Looking further ahead, while the outlook is subject to some uncertainties arising from the new US administration’s rhetoric on trade policies, world trade is expected to expand broadly in line with global activity.

Chart 2

World trade in goods

(left-hand scale: three-month-on-three-month percentage changes; right-hand scale: diffusion index)

44 46 48 50 52 54 56 58 60 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 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 May 2017 (PMIs) and March 2017 (trade).

Overall, global growth is projected to increase gradually over the period 2017‑19. According to the June 2017 Eurosystem staff macroeconomic projections, world real GDP growth excluding the euro area is projected to accelerate from 3.2% in 2016 to 3.5% in 2017 and 3.8% in 2018-19. Euro area foreign demand growth is expected to increase from 1.3% in 2016 to 3.7% in 2017, followed by growth of 3.4% in 2018 and 3.5% in 2019. Compared with the March 2017 projections, global GDP growth is largely unrevised, while euro area foreign demand growth has been revised upwards for 2017, reflecting stronger import data around the turn of the year.

The uncertainty surrounding the baseline projections for global activity remains elevated, with the balance of risks tilted to the downside. On the upside, there is the possibility that improved sentiment – as evidenced in surveys and financial markets – will translate into a faster-than-expected revival of activity and trade in the short term. Key downside risks include an increase in trade protectionism; a disorderly tightening of global financial conditions, which could affect vulnerable EMEs in particular; possible disruptions associated with China’s reform and liberalisation process; and the potential for volatility derived from political and geopolitical uncertainties, including those related to negotiations about future relations between the United Kingdom and the European Union. Box 1 discusses the evolution of global risks in the past year.


Global price developments

Global consumer price inflation has stabilised as the effect of past commodity price increases begins to wane. Annual consumer price inflation in the OECD area edged up to 2.4% in April, compared with 2.3% in March. Excluding food and energy, OECD annual inflation increased slightly to 1.9% in April (Chart 3).

Chart 3

OECD consumer price inflation

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

-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 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 April 2017.

Commodity prices have fallen recently. Brent crude oil prices have fluctuated in the range of USD 48 to USD 56 per barrel since early March. The price fluctuations reflect shifting concerns among market participants about the likely success of the OPEC strategy to curtail production, amid still high oil inventories and rising US shale production. The prolongation of the output cut for nine months, which was agreed by OPEC and 11 non-OPEC countries on 25 May 2017, was widely anticipated by markets and priced in before the meeting. Hopes raised by some participating countries that there might be agreement on an even deeper or longer cut did not materialise, which led to a renewed price drop in the aftermath of the meeting of about 6% in US dollar terms. Looking ahead, the futures curve is signalling largely unchanged oil prices over the next three years. Non-oil commodity prices have declined by about 8% since early March.

Looking ahead, after a slight moderation in the near term, global inflation is expected to rise slowly. The recent decline in oil and other commodity prices should dampen inflation rates in the short term. Thereafter, slowly diminishing spare capacity at the global level is expected to support underlying inflation, while the current oil futures curve anticipates very stable oil prices over the projection horizon, pointing to a very limited contribution from energy prices to inflation.


Financial developments

Since the Governing Council’s monetary policy meeting in March, euro area sovereign bond yields have declined slightly, with some intra-period volatility. Corporate bond spreads have declined marginally and remain below the levels observed in early March 2016, when the corporate sector purchase programme (CSPP) was announced. Broad equity prices have risen by a larger extent in the euro area than in other major economic areas. The value of the euro has appreciated in trade-weighted terms.

Long-term euro area government bond yields have decreased slightly overall since early March. During the period under review, from 9 March to 7 June 2017, the ten-year euro area overnight index swap (OIS) rate declined by around 10 basis points to 0.55%, while the GDP-weighted ten-year euro area sovereign bond yield decreased by around 25 basis points to just above 1% (see Chart 4). This decline brought to halt the period of rising nominal yields that had been ongoing in the euro area, although with some oscillations, since early October 2016. In the United States, long-term government bond yields declined more than in the euro area, but from a higher level, declining by around 45 basis points to 2.2%. The slight decline in long-term euro area interest rates since early March took place amid some volatile episodes caused by a number of factors. Long-term euro area government bond yields initially rose in the aftermath of the March Governing Council Meeting, but towards the end of March they declined, partly on account of market perceptions of increased political uncertainty in the run-up to the first round of the French presidential election. However, in the course of April, yields began to rise again amid a decline in political uncertainty and positive data releases for the euro area economy. In the remainder of the review period, long-term euro area government bond yields recorded slight declines on the back of some moderation in global inflation expectations and more negative economic surprises abroad.

Chart 4

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 01/16 03/16 05/16 07/16 09/16 11/16 01/17 03/17 05/17 euro area United States United Kingdom

Sources: Bloomberg and ECB.
Notes: For the euro area, the GDP-weighted average of ten-year euro area sovereign bond yields is reported. The latest observation is for 7 June 2017.

Sovereign bond yields declined markedly in a number of countries, mainly on account of the declining political uncertainty since late April as well as an improving economic outlook. Across countries, the declines ranged from a few basis points to around 120 points in Greece and Portugal. Sovereign yield spreads vis-à-vis the OIS also declined overall, mostly since the second half of April (see Chart 5).

Chart 5

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

(percentages per annum)

-1 0 1 2 3 4 01/16 03/16 05/16 07/16 09/16 11/16 01/17 03/17 05/17 euro area Germany France Italy Spain Portugal

Sources: Thomson Reuters and ECB calculations.