Economic and monetary developments

Overview

At its monetary policy meeting on 8 March 2018, the Governing Council concluded that 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. The information that has become available since the previous monetary policy meeting in January, including the new ECB staff projections, confirmed a strong and broad-based growth momentum in the euro area economy, which is projected to expand in the near term at a somewhat faster pace than previously expected. This outlook for growth confirmed the Governing Council’s confidence that inflation will converge towards the inflation aim of below, but close to, 2% over the medium term. At the same time, measures of underlying inflation remained subdued and have yet to show convincing signs of a sustained upward trend. In this context, the Governing Council will continue monitoring developments in the exchange rate and financial conditions with regard to their possible implications for the medium-term outlook for price stability. The continued monetary support required for a sustained return of inflation rates towards levels that are below, but close to, 2% is provided by the ongoing net asset purchases, by the sizeable stock of acquired assets and the forthcoming reinvestments, and by the forward guidance on interest rates.

Economic and monetary assessment at the time of the Governing Council meeting of 8 March 2018

The global economy expanded at an even faster rate in the second half of 2017 and is providing further impetus to euro area exports. Global economic activity is expected to remain strong going forward, although the pace of growth will gradually moderate. Global trade growth is expected to remain sustained in the near term, while inflation is expected to rise slowly as spare capacity at the global level diminishes.

Amid the ongoing economic expansion, euro area sovereign bond yields have increased since mid-December 2017. However, corporate bond spreads have remained broadly stable and average sovereign bond spreads over the overnight index swap rate have decreased somewhat overall. Equity prices have declined in an environment of heightened volatility. In foreign exchange markets, the euro has appreciated in nominal effective terms.

The euro area economic expansion continues to be strong and broad-based across countries and sectors, with real GDP increasing by 0.6% quarter on quarter in the fourth quarter of 2017. Private consumption is supported by rising employment, which is also benefiting from past labour market reforms, and by growing household wealth. Business investment has continued to strengthen on the back of very favourable financing conditions, rising corporate profitability and solid demand, while housing investment has improved further over recent quarters. In addition, the broad-based global expansion is providing impetus to euro area exports.

This assessment is also broadly reflected in the March 2018 ECB staff macroeconomic projections for the euro area, which foresee annual real GDP in the euro area increasing by 2.4% in 2018, 1.9% in 2019 and 1.7% in 2020. Compared with the December 2017 Eurosystem staff macroeconomic projections, the outlook for GDP growth has been revised up in 2018 and remains unchanged thereafter. Risks surrounding the growth outlook are assessed as broadly balanced. On the one hand, the prevailing cyclical momentum could lead to stronger growth in the near term. On the other hand, downside risks continue to relate primarily to global factors, including rising protectionism and developments in foreign exchange and other financial markets.

According to Eurostat’s flash estimate, euro area annual HICP inflation decreased to 1.2% in February, from 1.3% in January. This reflected mainly negative base effects in unprocessed food price inflation. Looking ahead, on the basis of current futures prices for oil, annual rates of headline inflation are likely to hover around 1.5% for the remainder of the year. Measures of underlying inflation remained subdued but 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 March 2018 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation at 1.4% in 2018, 1.4% in 2019 and 1.7% in 2020. Compared with the December 2017 Eurosystem staff macroeconomic projections, the outlook for headline HICP inflation has been revised down slightly for 2019 but remains unchanged for 2018 and 2020. Declines in HICP energy inflation in 2018 and 2019 are expected to broadly offset a strengthening in underlying inflation, with HICP inflation excluding energy and food rising from 1.1% in 2018 to 1.5% in 2019 and 1.8% in 2020.

The latest staff projections also foresee the euro area budget deficit declining further over the projection horizon, mainly as a result of favourable cyclical conditions and decreasing interest payments. The aggregate fiscal stance for the euro area is projected to remain on average broadly neutral in 2018-20. Although the euro area government debt-to-GDP ratio will continue to decline, it will still remain elevated. The current economic expansion calls for rebuilding fiscal buffers.

The monetary analysis showed broad money continuing to expand at a robust pace, with an annual rate of growth of 4.6% in January 2018 – unchanged from the previous month – reflecting the impact of the ECB’s monetary policy measures and the low opportunity cost of holding the most liquid deposits. Accordingly, the narrow monetary aggregate M1 continued to be the main contributor to broad money growth. At the same time, the recovery in loan growth to the private sector progressed. The pass-through of the monetary policy measures continued to support borrowing conditions for firms and households, access to financing – notably for small and medium-sized enterprises – and credit flows across the euro area.


Monetary policy decisions

Based on the regular economic and monetary analyses, 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%. 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 are intended to run at the current monthly pace of €30 billion 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. The Governing Council also reiterated that the Eurosystem will continue to 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

The global economy expanded at an even faster rate in the second half of 2017. Global economic activity is expected to remain strong going forward, although the pace of growth will gradually moderate. The outlook for advanced economies is for robust expansion, reinforced by the significant fiscal stimulus in the United States. For emerging market economies, the outlook is supported by strengthening activity among commodity exporters. Global trade growth is seen to remain buoyant in the near term, while inflation is expected to rise slowly as spare capacity at the global level diminishes.

Global economic activity and trade

The pace of global economic expansion strengthened in the second half of 2017. Overall, data releases in this period surprised on the upside in both advanced economies and, to a lesser extent, emerging market economies (EMEs). Available GDP data across countries point to a sustained expansion of global economic activity in the final quarter of the year. Specifically, US real GDP growth proved resilient in the second half of 2017, shaking off the impact of the hurricanes. Economic activity in Japan also remained brisk, benefiting from policy support, solid job creation and recovering external demand. By contrast, real GDP growth in the United Kingdom remained relatively muted in 2017, in spite of a moderate rebound in the second half of the year. Activity across EMEs has been supported by resilient growth in India and China, while the recoveries from deep recessions in Brazil and Russia continued, albeit at a very gradual pace.

Survey-based indicators point to sustained global growth in the near term. The global composite output Purchasing Managers’ Index (PMI), excluding the euro area, remained at a similar level in the last quarter of 2017 to that of the previous quarter – slightly above the first half of the year and close to the long-run average – and improved marginally in January and February, suggesting that global activity continued to expand robustly into this year (Chart 1).

Chart 1

Global composite output PMI

(diffusion index)

48 50 52 54 56 58 2011 2012 2013 2014 2015 2016 2017 2018 global excluding euro area global excluding euro area long-term average advanced economies excluding euro area emerging market economies

Sources: Haver Analytics, Markit and ECB staff calculations.
Notes: The latest observations are for February 2018. “Long-term average” refers to the period from January 1999 to February 2018.

Global financial conditions remain supportive of the global outlook but have tightened in recent weeks. Following a period of buoyant sentiment and large increases in equity market valuations, stock markets started to suffer sharp losses at the beginning of February, while volatility picked up. The financial market turmoil remained concentrated in equity markets, and the correction, while large, only unwound the gains made since the start of the year. However, the market volatility came against the background of a steady rise in long-term yields in the United States over the past three months, amid increasing investor nervousness about the inflation outlook and potentially faster than expected monetary policy tightening. The Fed Funds futures curve has shifted upwards in recent weeks, following last December’s rate hike. Markets continue to anticipate a gradual tightening and now price in the next policy rate increase in March 2018 and three hikes for the year as a whole – in line with the December projections of the Federal Open Market Committee. Interest rate expectations have also shifted upwards in the United Kingdom, following the hawkish tone of the Bank of England’s February Inflation Report. By contrast, the Bank of Japan has retained a very accommodative stance, holding ten-year yields close to zero in line with its yield curve control programme. In China, the People’s Bank of China sought to curb leverage in the financial system and contain financial stability risks with tightened financial conditions in the course of 2017, increasing the rates it charges on open-market operations with a view to guiding interbank rates upwards. Among other EMEs, in particular Brazil and Russia, policy rates have been lowered further as inflationary pressures have subsided.

Looking ahead, global economic activity growth is expected to remain resilient before moderating somewhat over the medium term. The outlook for advanced economies is for robust expansion, now reinforced by the additional fiscal impact emanating from the US tax reform and agreement on increased expenditure by the US Congress. However, growth is seen to slow going forward, as the recovery matures in some countries and output gaps become more positive. For EMEs, the outlook is supported by strengthening activity among commodity exporters like Brazil and, to a lesser extent, Russia. At the same time, growth remains resilient in India, while activity continues to follow a gradual long-term downward trend in China.

The pace of global expansion is projected to remain below pre-crisis levels, in line with lower potential growth. ECB estimates suggest that the growth potential has declined across most advanced and emerging economies in recent years. In advanced economies, all components weigh on potential, although this is particularly true of labour and total factor productivity (TFP) contributions. Capital contributions also remain below historical averages, as weakened expectations of growth prospects and heightened uncertainty have delayed investment decisions. Investment has similarly moderated in EMEs, in commodity-exporting countries in particular but also in China in response to its rebalancing process and policy drive to contain leverage. However, TFP was the main factor behind the decline in potential among EMEs. Overall, potential output growth is expected to remain broadly stable in advanced economies over the medium term, a slight increase in US potential growth in 2019‑20 notwithstanding, while it is expected to continue declining in EMEs.

In the United States, activity is expected to remain robust on the back of solid domestic demand. The ongoing expansion is seen to proceed on the back of solid growth in investment and consumer spending, as tight labour market conditions gradually feed into higher wage growth and still favourable financial conditions boost wealth. The approval of tax reform legislation last December and the rise in the ceilings on government expenditure agreed in February are projected to further boost domestic demand.

In the United Kingdom, real GDP growth is expected to remain subdued yet resilient. Economic activity rebounded moderately in the second half of the 2017, having slowed markedly in the first half. Looking ahead, a boost from stronger net export growth over the coming quarters and a slight rebound in investment will underpin the resilience of real GDP growth in the United Kingdom.

In Japan, the economic expansion is seen to gradually decelerate. Economic activity is projected to remain relatively solid over the short term, benefiting from the current positive momentum and accommodative monetary policy stance. Looking further ahead, however, growth is expected to gradually slow. Apart from diminishing support from fiscal policy and quickly contracting spare capacity, this deceleration also reflects a decline in the positive impact of infrastructure investment related to the 2020 Olympics.

In China, activity continues to expand at a robust pace, supported by strong consumption and a still thriving housing market. The near-term outlook is dominated by the authorities’ focus on stable growth and the mitigation of financial risks. The assumption over the medium term is that continued structural reforms will gradually be implemented, leading to an orderly growth slowdown.

Economic activity in central and eastern European countries will remain robust, albeit at a more moderate pace than in 2017. Economic activity in central and eastern European countries grew strongly in 2017, driven by a rebound in investment and solid private consumption. Looking forward, it is expected to remain supported by strong investment, linked to the absorption of EU funds, solid consumer spending and improvements in the labour market.

Economic activity is gradually strengthening in the large commodity-exporting countries. In Russia, leading indicators signal a temporary dip in economic activity in the last quarter of 2017, following robust growth in the first half of the year, as industrial production declined. Over the medium term, economic activity is expected to expand moderately, amid fiscal challenges weighing on the business environment, weak fixed investment and growth potential undermined by a lack of structural reforms. Activity in Brazil should continue recovering. Rising confidence, an improved labour market and continuing monetary accommodation should support consumption, against the backdrop of inflationary pressures remaining contained. Political uncertainty in this election year and a potential reversal of the benign external financial conditions are key risks to the country’s improving economic outlook.

Global trade growth prospects are expected to remain sustained in the near term. While global merchandise import growth momentum receded somewhat in December, available country data and leading indicators point to robust growth at the turn of 2017‑18. The volume of merchandise imports increased by 1% in December (in three-month-on-three-month terms), down from 1.6% in the third quarter (Chart 2). Trade activity picked up substantially in the United States, while weakening in Asia and central and eastern Europe.

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 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 2011 2012 2013 2014 2015 2016 2017 2018 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 February 2018 (global PMI manufacturing and global PMI new export orders) and December 2017 (trade).

Over the medium term, the trade projections are anchored in the view that global imports will grow broadly in line with activity. This is consistent with the evidence that the longer-term structural factors that previously drove the fast expansion of global trade – including trade liberalisation, reductions in tariffs and transportation costs and the expansion of global value chains – have waned since the financial crisis. Uncertainty about these longer-term factors is clearly high and, in some instances, data are scarce. But the available evidence would suggest that the projection for imports to grow in line with activity over the medium term remains a reasonable baseline.

Overall, global growth is projected to remain broadly stable over the projection horizon. According to the March 2018 ECB staff macroeconomic projections, world real GDP growth (excluding the euro area) is expected to increase from 3.8% in 2017 to 4.1% in 2018 before declining to 3.9% and 3.7% in 2019 and 2020 respectively. This projection path reflects the anticipated slowdown in activity in advanced economies in general, and the United States in particular, partly offset by a modest gain in dynamism in EMEs. Growth in euro area foreign demand is forecast to expand by 4.7% in 2018, 4.1% in 2019 and 3.6% in 2020. Compared with the December 2017 projections, global GDP growth has been revised upwards for 2017‑19, while growth in euro area foreign demand has been revised upwards over the whole projection horizon, in both cases mostly reflecting the impact of the additional fiscal stimulus in the United States.

Although on the upside in the short term, risks to the outlook for global activity remain skewed to the downside in the medium term. On the upside, the broadening of the global recovery could lead to stronger investment and trade in the short term, while the US fiscal package could have a stronger impact on activity than currently anticipated. Over the medium term, however, these factors are seen to be outweighed by downside risks such as an increase in trade protectionism, a sudden financial market correction – which would result in a tightening of global financial conditions – disruptions associated with China’s reform and liberalisation process, and political and geopolitical uncertainties associated with Brexit-related risks in particular.


Global price developments

Global consumer price inflation has declined slightly of late, while wage developments have remained subdued. Following a slight increase in November, annual consumer price inflation in the OECD area slowed in December and in January, to 2.2%. This resulted from a slight deceleration in energy price rises, although still close to 5%, while food price inflation remained stable. Excluding food and energy, OECD annual inflation declined marginally to 1.8% (Chart 3). Turning to wages, compensation per employee remained broadly unchanged at very low levels (rising 1.5% year-on-year), in spite of a further decline in the OECD unemployment rate in the third quarter (to below 6%). Only hourly earnings in the manufacturing sector show a swift upward trend, more in line with the tightening of the labour market.

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 2018 energy contribution food contribution excluding food and energy contribution excluding food and energy all items

Source: OECD.
Note: The latest observation is for January 2018.

Brent crude oil prices have declined somewhat over the last few weeks, from USD 70 per barrel on 23 January to USD 66 on 22 February. This recent decline was underpinned by record US crude production, high compliance with the OPEC/non-OPEC agreement to reduce supply and the end of the pipeline disruption suffered during December and January – notably including the return of the North Sea pipeline to full capacity. Oil futures suggest that oil prices will fall below current levels, to around USD 65 per barrel in 2018 and USD 61 per barrel in 2019. Non-energy commodity prices have increased slightly in recent weeks, with food prices rising by 3.5% and metal prices by 1.6%.

Looking ahead, global inflation is expected to rise slowly. In the short term, inflation is seen to increase following the recent pick-up in oil prices. Thereafter, the slowly diminishing spare capacity at the global level is projected to further support underlying inflation. However, the rise in inflation is seen to be moderated by a negative contribution from energy prices to inflation, as currently implied by an oil futures curve that anticipates falling oil prices over the medium term.


Financial developments

Since the Governing Council’s meeting in December 2017 euro area sovereign bond yields have increased, against the background of the ongoing economic expansion. As inflation expectations have remained broadly stable, real interest rates have recorded a corresponding rise. Although corporate earnings expectations have improved, equity prices have declined in an environment of heightened volatility. At the same time, corporate bond spreads have remained broadly stable. Average sovereign bond spreads vis-à-vis the overnight index swap (OIS) rate have decreased somewhat overall. In foreign exchange markets, the euro has appreciated in nominal effective terms.

Long-term government bond yields have increased on both sides of the Atlantic since mid-December. During the period under review (from 14 December 2017 to 7 March 2018) the GDP-weighted euro area ten‑year sovereign bond yield increased by 28 basis points, to 1.13% (see Chart 4). In the United States and the United Kingdom, long-term government bond yields increased by 53 basis points and 33 basis points, to 2.88% and 1.50% respectively. The euro area ten-year OIS rate increased by 31 basis points to stand at 0.90%, mainly driven by an increase in the long-term real interest rate. Overall, bond market developments on both sides of the Atlantic reflect improving market expectations of economic growth and inflation, as well as revisions to expectations regarding the associated monetary policy reaction.

Chart 4

Ten-year sovereign bond yields

(percentages per annum)