Update on economic and monetary developments

Summary

The information that has become available since the Governing Council’s last meeting of the year 2017 confirms a robust pace of economic expansion, which accelerated more than expected in the second half of 2017.[1] The strong cyclical momentum, the ongoing reduction of economic slack and increasing capacity utilisation strengthened further the Governing Council’s confidence that inflation will converge towards its inflation aim of below, but close to, 2%. The risks surrounding the euro area growth outlook are broadly balanced. On the one hand, the prevailing strong cyclical momentum could lead to further positive growth surprises in the near term. On the other hand, downside risks continue to relate primarily to global factors, including developments in foreign exchange markets.

The global economy is continuing to expand at a solid rate, with increasing signs of synchronisation. Activity is benefiting from favourable global financial conditions and strong sentiment. Rising oil prices have contributed to increasing global inflation, but inflation excluding food and energy prices has remained more stable.

Amid this improved economic sentiment, euro area yields and equities have risen since the Governing Council’s meeting in December. In foreign exchange markets, the euro appreciated overall in trade-weighted terms, in particular against the US dollar. This recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium‑term outlook for price stability.

The economic analysis based on the latest economic data and survey results indicates continued strong and broad-based growth momentum at the turn of the year. Private consumption is supported by rising employment, which is also benefiting from past labour market reforms, and by growing household wealth. Business investment continues to strengthen on the back of very favourable financing conditions, rising corporate profitability and solid demand. Housing investment has improved further over recent quarters. In addition, the broad-based global expansion is providing impetus to euro area exports.

Euro area annual HICP inflation was 1.4% in December 2017, down from 1.5% in November, mainly reflecting developments in energy prices. Looking ahead, on the basis of current futures prices for oil, annual rates of headline inflation are likely to hover around current levels in the coming months. Measures of underlying inflation remain subdued – in part owing to special factors – and have yet to show convincing signs of a sustained upward trend. Looking forward, they are expected to rise gradually over the medium term, supported by the ECB’s monetary policy measures, the continuing economic expansion, the corresponding absorption of economic slack and rising wage growth.

The monetary analysis confirms that broad money growth continued to expand at the robust pace generally witnessed since mid-2015. The recovery in loan growth to the private sector also continued. The euro area bank lending survey for the fourth quarter of 2017 shows that loan growth was still supported by increasing loan demand and the easing of credit standards for loans, in particular to households. Moreover, financing costs for euro area non-financial corporations (NFCs) have remained favourable, with bank lending rates for NFCs being close to their historical lows.

Considering the outcome of the economic analysis with the signals coming from the monetary analysis, the Governing Council confirmed the need for an ample degree of monetary accommodation to secure a sustained return of inflation rates towards levels that are below, but close to, 2%. While the Governing Council’s confidence that inflation will converge towards its inflation aim has strengthened, domestic price pressures remain muted overall and have yet to show convincing signs of a sustained upward trend. Therefore, an ample degree of monetary stimulus remains necessary for underlying inflation pressures to continue to build up and support headline inflation developments over the medium term.

Accordingly, the Governing Council decided to keep the key ECB interest rates unchanged and continues to expect 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, at the new monthly pace of €30 billion in place since January, are intended to run until the end of September 2018, 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. Moreover, the Governing Council reconfirmed that 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. Finally, the Governing Council reiterated that the Eurosystem will reinvest the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary.


External environment

Global growth has continued to firm up. Following solid global GDP growth in the third quarter of 2017, survey indicators point to sustained global growth momentum in the final months of last year. The global composite output Purchasing Managers’ Index (PMI) increased to 54.4 in December, from 54.0 in the previous month. The strong performance in December reflected ongoing robust expansion in advanced economies and a pick-up in emerging economies, driven by China and India in particular. The latest data are consistent with indications of an ongoing broad-based and synchronised global economic recovery (see Chart 1).

Chart 1

Industrial production and manufacturing PMI

(monthly data; percentage share of countries with rising growth in industrial production; percentage share of countries with a PMI manufacturing diffusion index above 50)

0 10 20 30 40 50 60 70 80 90 100 2013 2014 2015 2016 2017 industrial production (excluding construction) manufacturing PMI

Sources: Markit, national sources, OECD and ECB calculations.
Notes: The latest observations are for September 2017 for industrial production and December 2017 for the manufacturing PMI. The chart comprises data for 19 advanced and emerging market economies. For industrial production, the line shows the share of countries where the three-month average annual change in industrial production is higher than the previous three-year average annual change.

Survey indicators point to continued strong global trade momentum in the final quarter of 2017. Global goods import growth slowed in the first months of the fourth quarter, with the volume of merchandise imports increasing by 0.8% in three-month-on-three-month terms in November, following growth of 1.6% in the third quarter (see Chart 2). The decline was driven by a moderation in imports in Asia and in a number of advanced economies. However, trade indicators have been more resilient, suggesting that in the fourth quarter world imports expanded at a pace similar to that seen in the third quarter. Global PMI new export orders rose to 53.8 in December, from 53.7 in the previous month, which is above its long-term average.

Chart 2

Global trade and surveys

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

44 46 48 50 52 54 56 58 60 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 2011 2012 2013 2014 2015 2016 2017 global merchandise imports (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 Netherlands Bureau for Economic Policy Analysis and ECB calculations.
Note: The latest observations are for November 2017 for global merchandise imports and December 2017 for the PMIs.

Global inflation picked up in November. Annual consumer price inflation in the OECD area increased to 2.4% in November, from 2.2% in October, reflecting acceleration in energy and food prices. However, excluding food and energy, inflation remained stable at 1.9%.

Oil prices have continued to increase in recent weeks. Brent crude oil prices rose from around USD 64 per barrel in mid-December to over USD 69 per barrel. Higher oil prices during this period partly reflect supply disruptions, notably the closing of the Forties pipeline in the North Sea for repairs, and political unrest in the Middle East. Strong demand for crude oil imports in China and increased US refining activity that drew more crude from inventories were also factors driving the recent oil price rise. Non-oil commodity prices have also increased in recent weeks, driven particularly by increases in metal prices. Rising metal prices are related to supply disruptions in non-ferrous metal industries following the introduction of environmental regulation in China and to rising demand for iron ore.

The cyclical upswing has continued in the United States. After solid third-quarter GDP growth at an annualised rate of 3.2%, growth is expected to have remained robust in the fourth quarter of last year. Activity is supported by accommodative financial conditions and buoyant confidence as well as the temporary boost associated with the reconstruction efforts after the hurricanes in the autumn. In line with robust economic activity, the labour market continued to tighten, with a gain in non-farm payroll employment of 148,000 in December, while the unemployment rate stayed unchanged at 4.1%. Notwithstanding tight labour market conditions, annual wage growth remains subdued, with a slight increase to 2.5% in December. Annual headline CPI inflation declined to 2.1% in December on account of lower energy price inflation, but CPI inflation excluding food and energy firmed, rising to 1.8% on an annual basis in December, from 1.7% in the previous month. The Federal Open Market Committee (FOMC) continued its gradual removal of policy accommodation by raising the target range for the federal funds rate to 1.25-1.50% in December. The US administration has also reached agreement on tax reform. The Tax Cuts and Jobs Act, which took effect on 1 January 2018, permanently lowers corporate taxes, provides relief to small businesses, temporarily lowers personal income taxes and broadens the tax base. The resulting revenue loss from lower taxes is expected to be partially offset by additional taxes charged on income earned abroad by US multinationals. Overall, the fiscal stimulus provided by the reform is likely to boost US economic activity, although it could also exacerbate fiscal imbalances.

In Japan, economic activity remains strong and the labour market continues to tighten. Real GDP grew by 0.6% quarter-on-quarter in the third quarter of 2017 and recent economic indicators continue to point to firm growth in the final quarter of last year. The labour market continues to tighten, with the unemployment rate falling to 2.7% in November, close to the levels of the early 1990s. Nonetheless, wage pressures remain modest, with total nominal cash earnings rising by 0.9% in year-on-year terms in November. Annual headline CPI inflation picked up in November to 0.6%, but inflation excluding food and energy remained close to zero. Moreover, the latest Tankan survey of inflation expectations suggests that firms remain cautious about further price increases.

In the United Kingdom, economic activity rebounded slightly, having slowed markedly in the first half of 2017. Real GDP growth slightly accelerated to 0.4% in the third quarter according to the final estimate. Recent indicators point to a continuation of growth at similar rates around the turn of the year. Survey indicators suggest a buoyant performance for export business, with the PMI Export Climate Index and data on new export orders from the manufacturing sector remaining at high levels in the final quarter of 2017. By contrast, indicators suggest that services activity growth has moderated. Annual CPI inflation marginally decelerated to 3.0% in December 2017, from 3.1% in November, but is expected to continue to weigh on disposable income.

In China, economic activity indicators point to resilient growth. GDP expanded by 6.8% in year-on-year terms in the fourth quarter of the year. Overall in 2017, output was 6.9% higher than in the previous year, above the government’s target of 6.5%. Consumer price inflation registered a slight increase in December, rising to 1.8% from 1.7% in the previous month. A fall in mining and raw material price inflation pushed producer price inflation down to 4.9% in December, from 5.8% in the previous month. The December Central Economic Work Conference, an annual meeting which sets the national agenda for the Chinese economy, confirmed that the authorities see high-quality growth, further supply-side reforms and mitigating financial risks as the main priorities for 2018.


Financial developments

Euro area government bond yields have risen since mid-December (see Chart 3). In the period under review (from 14 December to 24 January), the GDP-weighted euro area ten-year sovereign bond yield increased by 18 basis points to 1.04%. These developments reflect improving market expectations for euro area economic growth and markets’ revisions to the future course of monetary policy. The euro area ten-year overnight index swap (OIS) rate increased by 21 basis points to currently stand at 0.8%. Thus the spread between the GDP-weighted yield and the OIS rate increased slightly during the review period. This development masks diverging movements in the yield curves of individual countries. For Germany, the ten-year yield spread vis-à-vis the risk-free OIS rate became somewhat less negative, possibly reflecting lower scarcity premia, while in Italy it widened amid market perceptions of increased political uncertainty. In contrast, the yield spreads on Portuguese and Spanish sovereign bonds continued their downward trajectory amid improvements in macroeconomic fundamentals. In the United Kingdom, the ten-year gilt yield increased by 23 basis points to stand at 1.41%, while in the United States the passage of the tax reform contributed to a 30 basis points increase in the 10-year Treasury yield to 2.66%.

Chart 3

Ten-year sovereign bond yields

(percentages per annum)

-0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 01/15 04/15 07/15 10/15 01/16 04/16 07/16 10/16 01/17 04/17 07/17 10/17 01/18 GDP-weighted euro area average United Kingdom United States Germany

Sources: Thomson Reuters and ECB calculations.
Notes: The vertical grey line denotes the start of the review period (14 December 2017). The latest observation is for 24 January 2018.

Yield spreads on bonds issued by non-financial corporations (NFCs) remained broadly stable during the period under review. Since mid-December, the spread on investment-grade NFC bonds relative to AAA-rated euro area bonds declined slightly by 5 basis points to 31 basis points. Spreads on financial sector debt with investment grade rating decreased slightly more, by 7 basis points. These developments are consistent with a strengthening of the economic expansion.

Broad indices of euro area equity prices rose over the review period. Equity prices of euro area NFCs increased by around 3.0%, while prices rose by 5.8% in the case of euro area bank equities. Favourable corporate profit expectations and reduced equity risk compensation, both fuelled by the positive macro environment, more than compensated for the dampening effect stemming from higher yields. The equity prices of US NFCs and banks also increased over the review period, by 7.1% and 6.7% respectively. Market expectations of equity price volatility in the euro area remained constant, whereas they increased in the United States. Both are still quoted at levels (12.4% and 11.5% respectively) which are comparatively low from a historical perspective.

The euro overnight index average (EONIA) stood at an average of -36 basis points. Excess liquidity declined by around €9 billion to around €1,871 billion, as growth in net autonomous factors was greater than the amount of liquidity provided through ongoing purchases under the Eurosystem’s asset purchase programme.

The EONIA forward curve shifted upwards over the review period, in particular for medium-term horizons. Market sentiment regarding the course of monetary policy in 2018 remained unchanged. Beyond that horizon, market participants increased their interest rate expectations.

In foreign exchange markets, the euro appreciated overall in trade-weighted terms (Chart 4). Over the period under review, the effective exchange rate of the euro appreciated by 0.7%. In bilateral terms, the euro appreciated vis-à-vis the currencies of most advanced economies, including the US dollar in particular (by 4.3%), but also the Japanese yen (by 1.3%) and the Swiss franc (by 0.4%). The euro also mostly strengthened against the currencies of emerging economies, including, most notably, the Chinese renminbi (by 0.6%), as well as currencies of other major trading partners in Asia. This broad-based appreciation was only partly offset by a weakening of the euro against the currencies of other EU Member States, including the pound sterling against which it weakened 1.1%.

Chart 4

Changes in the exchange rate of the euro vis-à-vis selected currencies

(percentage changes)

-10 -5 0 5 10 15 20 Croatian kuna Indian rupee Brazilian real Taiwan dollar Romanian leu Danish krone Hungarian forint Indonesian rupiah South Korean won Turkish lira Russian rouble Swedish krona Czech koruna Polish zloty Japanese yen Swiss franc Pound sterling US dollar Chinese renminbi EER-38 since 14 December 2017 since 24 January 2017

Source: ECB.
Notes: “EER-38” is the nominal effective exchange rate of the euro against the currencies of 38 of the euro area’s most important trading partners. All changes have been calculated using the foreign exchange rates prevailing on 24 January 2018.


Economic activity

The broad-based and solid economic expansion in the euro area is continuing. Real GDP increased by 0.7%, quarter on quarter, in the third quarter of 2017, following a rise of the same magnitude in the previous quarter (see Chart 5), on the back of positive contributions from domestic demand and net trade. At the same time, changes in inventories made a neutral contribution to GDP growth in the third quarter. The latest economic indicators, both hard data and survey results, remain elevated and confirm the expectation of continued robust growth around the turn of the year at rates similar to those observed in the previous two quarters.

Chart 5

Euro area real GDP, the Economic Sentiment Indicator and the composite output Purchasing Managers’ Index

(quarter-on-quarter percentage growth; diffusion index)

-0.6 -0.3 0.0 0.3 0.6 0.9 1.2 44 47 50 53 56 59 62 2011 2012 2013 2014 2015 2016 2017 2018 real GDP (right-hand scale) ESI (left-hand scale) composite output PMI (left-hand scale)

Sources: Eurostat, European Commission, Markit and ECB.
Notes: The Economic Sentiment Indicator (ESI) is standardised to have the same mean and standard deviation as the Purchasing Managers’ Index (PMI). The latest observations are for the third quarter of 2017 for real GDP, December 2017 for the ESI and January 2018 for the PMI.

Consumer spending has risen further, thus continuing to play its key role in supporting the ongoing economic expansion. Private consumption rose by 0.4%, quarter on quarter, in the third quarter of 2017, following a somewhat higher rate of increase in the previous quarter. This slowdown largely reflects lower goods consumption growth, whereas services consumption appears to have risen at broadly the same rate in the third quarter as in the second quarter. However, growth in durable goods consumption continues to outpace growth in semi-durable and non-durable goods consumption (see Box 2). On an annual basis, consumption rose by 1.9% in the third quarter of 2017, the same rate as in the second quarter. This stable pattern contrasts with a rise in the growth of households’ real disposable income to 1.6%, year on year, in the third quarter, from 1.3% in the previous quarter. Consistent with the unchanged consumption growth and higher income growth in the third quarter of 2017, the annual rate of change in savings increased in the third quarter. However, the saving ratio (expressed as a four-quarter moving average) declined to a new record low of 12% in the third quarter.

Euro area labour markets continue to improve, thus underpinning household income and consumer spending. Employment rose further, by 0.4% quarter on quarter in the third quarter of 2017, which led to an annual increase of 1.7%. Employment currently stands 1.2% above its pre-crisis peak in the first quarter of 2008. The unemployment rate in the euro area stood at 8.7% in November 2017, down from 8.8% in October and 3.3 percentage points below the post-crisis peak in April 2013 (see Chart 6). This decline has been broad-based across age and gender groups. Long-term unemployment (i.e. the number of people who have been unemployed for at least 12 months expressed as a percentage of the labour force) also continues to decline, but remains above its pre-crisis level. Survey information points to continued employment growth in the period ahead, and in some countries and sectors there are increasing signs of labour shortages.

Chart 6

Euro area employment, PMI employment expectations and unemployment

(quarter-on-quarter percentage changes; diffusion index; percentage of labour force)

8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 12.5 13.0 -0.4 -0.3 -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 2011 2012 2013 2014 2015 2016 2017 2018 employment (left-hand scale) PMI employment expectations (left-hand scale) unemployment rate (right-hand scale)

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 third quarter of 2017 for employment, January 2018 for the PMI and November 2017 for the unemployment rate.

Consumption is expected to remain resilient and continue to increase. Recent data on retail trade and new passenger car registrations point to a broadly unchanged consumer spending growth pattern in the fourth quarter of 2017 compared with the third quarter. Other indicators support the picture of continued robust consumption dynamics. The latest survey indicators point to further labour market improvements, which – via employment gains – should continue to boost aggregate income and thus consumer spending. Moreover, households’ net worth continued to increase at robust rates, thus lending further support to consumer spending. These factors may partly explain why consumer confidence improved further in the fourth quarter, with the December 2017 reading standing at the highest level since January 2001.

Following a strong second quarter, business investment contracted in the third quarter of 2017. However, this weak outcome is largely technical in nature and relates mainly to the introduction of Irish data into the euro area national accounts and the associated impact from investment in intellectual property products and leasing-related aircraft purchases. As a result, non-construction investment in the euro area declined by 1.2% quarter on quarter in the third quarter of 2017. As regards the fourth quarter, continued favourable conditions in the capital goods sector, such as increasing capacity utilisation, rising orders, as well as stronger confidence and demand, signal overall a continuation of the dynamic investment momentum. Monthly data on capital goods production up to November also suggest rising business investment in the near term. With regard to construction investment, monthly construction production data until November point to somewhat slower growth in the fourth quarter of 2017 compared with the third quarter. However, survey indicators on the demand situation and the assessment of order books in the sector, as well as the number of building permits issued, are in line with positive growth momentum around the turn of the year. In some countries, however, there are growing indications of capacity constraints in construction related to labour shortages.

Investment is expected to remain an important contributor to output growth in the period ahead. Investment should continue to be supported by very strong business confidence and lower uncertainty, higher capacity utilisation, accommodative financing conditions, stronger corporate profits and the widespread need to modernise the capital stock. According to the euro area sectoral accounts, the corporate gross operating surplus increased in the third quarter of 2017 at a higher year-on-year rate than in the previous quarter. Furthermore, earnings expectations for listed companies in the euro area continue to register high levels. As regards construction investment, features such as households’ rising disposable income and very favourable lending conditions should underpin demand in the construction sector. At the same time, some factors are expected to continue to weigh on the outlook for investment, including expectations of weaker growth over the medium term.

Export growth remained strong in the third quarter of 2017 and trade indicators point to sustained momentum going forward. Total euro area exports rose by 1.5% in the third quarter on account of strong goods exports, continuing the robust growth pattern seen earlier in 2017. Monthly trade in goods data up to November suggest that extra-euro area exports will continue to show positive growth in the fourth quarter of 2017, in line with the recovery in foreign demand. Exports in October seem to have been supported mainly by demand from outside the EU, with positive contributions also from EU economies.[2] Leading indicators, such as surveys, continue to signal ongoing improvements in euro area exports and foreign demand, while new manufacturing export orders from outside the euro area have risen further.

The latest economic indicators point to a continuation of the recent robust growth pattern in the short term. Industrial production (excluding construction) displayed a strong increase in November. As a result, production stood on average in October and November 1.0% above the level in the third quarter of 2017, when it rose by 1.2% on a quarterly basis. More timely survey data also signal solid growth dynamics in the near term. The composite output Purchasing Managers’ Index averaged 57.2 in the fourth quarter of 2017, compared with 56.0 in the third quarter, before rising further to 58.6 in January 2018. Meanwhile, the European Commission’s Economic Sentiment Indicator rose to 114.9 in the fourth quarter from 112.1 in the third quarter (see Chart 5). Both the ESI and the PMI stand well above their respective long-term averages.

The ongoing broad and solid economic expansion is expected to continue beyond the near term. The ECB’s monetary policy measures, which have facilitated the deleveraging process, continue to underpin domestic demand. Private consumption is supported by rising employment, which is also benefiting from past labour market reforms, and by growing household wealth. Business investment continues to strengthen on the back of very favourable financing conditions, rising corporate profitability and solid demand. Housing investment has improved further over recent quarters. In addition, the broad-based global expansion is providing impetus to euro area exports. The results of the latest round of the ECB Survey of Professional Forecasters, conducted in early January, show that private sector GDP growth forecasts were revised upwards for 2018 and 2019 in comparison with the previous round conducted in early October.

The risks surrounding the euro area growth outlook are assessed as broadly balanced. On the one hand, the prevailing strong cyclical momentum could lead to further positive growth surprises in the near term. On the other hand, downside risks continue to relate primarily to global factors, including developments in foreign exchange markets.


Prices and costs

Headline HICP inflation was 1.4% in December 2017, down from 1.5% in November (see Chart 7). The decrease mainly reflected lower energy inflation and, to a small extent, lower food inflation. HICP inflation excluding energy and food was 0.9% in December 2017, unchanged from November and October.

Chart 7

Contributions of components of euro area headline HICP inflation

(annual percentage changes; percentage point contributions)