Update on economic and monetary developments

Summary

Following several quarters of higher than expected growth, incoming information since the Governing Council’s meeting in early March points towards some moderation, while remaining consistent with a solid and broad-based expansion of the euro area economy.[1] The risks surrounding the euro area growth outlook remain broadly balanced, but risks related to global factors, including the threat of increased protectionism, have become more prominent. Overall, the economy’s underlying strength continues to support the Governing Council’s confidence that inflation will converge towards its inflation aim of below, but close to, 2% over the medium term. At the same time, measures of underlying inflation remain subdued and have yet to show convincing signs of a sustained upward trend. In this context, the Governing Council will continue to monitor developments in the exchange rate and other financial conditions with regard to their possible implications for the inflation outlook. Overall, 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.

On the global level, survey indicators remain generally consistent with a steady economic expansion. However, the tariff announcements in recent weeks represent a risk to global momentum. Global trade indicators were mixed but on the whole signal some deceleration at the start of the year. Furthermore, geopolitical risks have led to a pick-up in oil prices.

Euro area sovereign bond yields have declined and sovereign bond spreads have decreased, the latter reflecting an improvement in country-specific macroeconomic fundamentals in the light of the ongoing economic expansion. Similarly, euro area equity prices have risen despite some episodes of heightened volatility. In foreign exchange markets, the euro has remained broadly unchanged in nominal effective terms.

The analysis of the latest economic data and survey results suggests some moderation in the pace of growth since the start of the year. This moderation may in part reflect a pull-back from the high pace of growth observed at the end of last year, while temporary factors may also be at work. Overall, however, growth is expected to remain solid and broad-based. Private consumption is supported by ongoing employment gains (which, in turn, partly reflect 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 continues to improve. In addition, the broad-based global expansion is providing impetus to euro area exports.

Euro area annual HICP inflation increased to 1.3% in March 2018, from 1.1% in February, mainly reflecting higher 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 remain subdued overall. Going 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 shows broad money (M3) continuing to expand at a robust pace, only slightly below the narrow range observed since mid‑2015. M3 grew at an annual rate of 4.2% in February, 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 remained the main contributor to broad money growth, continuing to expand at a solid annual rate. The recovery in the growth of loans to the private sector observed since the beginning of 2014 is also proceeding. The euro area bank lending survey for the first quarter of 2018 indicates that loan growth continues to be supported by increasing demand across all loan categories, as well as a further easing in overall bank lending conditions.

On the basis of the economic analysis and 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% over the medium term. This continued monetary support is provided by the net asset purchases, by the sizeable stock of acquired assets and the ongoing and forthcoming reinvestments, and by the forward guidance on interest rates.

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 current monthly pace of €30 billion, 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. Finally, the Governing Council 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 the net asset purchases, and in any case for as long as necessary.


External environment

Global survey indicators remain consistent with a steady expansion of activity in the first quarter of 2018. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area decreased in March (see Chart 1), following declines in the manufacturing and service sectors. In quarterly terms, the PMI in the first quarter of 2018 remained slightly above the level recorded in the second half of 2017, pointing to an external environment that remained supportive of the euro area. The PMI was broadly unchanged in the United States during the first quarter, while it decreased in the United Kingdom and, to a lesser extent, in Japan, on the back of weaker outcomes in March. In emerging market economies, the quarterly PMI picked up in Brazil and China, while it edged down in India and Russia.

 

Chart 1

Global composite output PMI

(diffusion index)

image/svg+xml 48 50 52 54 56 58 60 2011 2012 2013 2014 2015 2016 2017 2018 global excluding euro area global excluding euro are – long-average advanced economies excluding euro area emerging market economies

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

The recent announcements of tariff increases by the United States represent a risk to global momentum. In late March, President Trump signed an order to impose import tariffs on steel and aluminium, to protect US industries from foreign competition. Furthermore, the US Administration announced increases in tariffs on USD 50 billion of Chinese goods. China has responded with a pledge to increase tariffs on similar amounts of US imports. Viewed in isolation, the measures announced so far are expected to have only a very small macroeconomic effect. However, the risks associated with a rise in protectionism have clearly increased. Expectations of an escalation in the dispute would affect investment decisions, with potentially more significant effects on global activity. Box 1 contains a detailed analysis of the implications of rising trade tensions for the global economy.

Global financial conditions remain supportive of the global outlook, sustained by still accommodative monetary policies. Despite the recent volatility, global equity markets remain buoyant. The Federal Funds futures curve shifted upwards following the rate hike at the Federal Open Market Committee’s March meeting. Markets continue to anticipate a gradual tightening, pricing in three further rate increases in 2018. Market expectations also suggest a rise in UK rates in the coming months, following the hawkish tone of the Bank of England’s February Inflation Report. By contrast, the Bank of Japan maintains a very accommodative stance, holding ten-year yields close to zero in line with its yield curve control programme. Financial conditions in emerging market economies also remain accommodative, benefiting from a sustained improvement in capital inflows over the past year. Bond spreads rose following the US Administration’s announcement on tariffs but remain low by historical standards. At the same time, conditions continue to improve in large commodity exporters, with both Brazil and Russia lowering policy interest rates further in March, as inflationary pressures remain subdued. China, however, continues to tighten domestic financial conditions to tackle risks in the financial system, raising its open-market interest rates again in March.

Global trade indicators were mixed but signal, overall, some deceleration at the start of the year. While the volume of merchandise imports increased by 2.2% in February 2018 (in three-month-on-three-month terms) – unchanged from the previous month – on account of sharp increases in Asian countries, trade indicators such as the PMI new export orders fell throughout the first quarter (see Chart 2). A broader measure, based on a principal component of leading indicators of global trade, also points to some moderation in the first quarter of 2018, compared with the previous quarter.

 

Chart 2

Global trade and surveys

(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) 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 staff calculations.
Note: The latest observations are for February 2018 for global merchandise imports and March 2018 for the PMIs.

Global inflation remained stable in February. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) stood at 2.2% in February, broadly in line with the average recorded in the second half of 2017. Excluding food and energy prices, OECD annual inflation edged up marginally to 1.9%. Looking ahead, inflation is expected to increase in the short-term following the recent pick-up in oil prices. Later, the slowly diminishing spare capacity at the global level is also expected to support underlying inflation.

Oil prices picked up in mid-March on account of increased geopolitical risks. By mid-April, Brent crude oil prices had risen above USD 73, a level last seen at the end of November 2014. Oil prices are supported by renewed geopolitical tensions concerning the US-Iran relationship, as well as by expectations of an extension of supply cuts by OPEC and non-OPEC countries, although in March a decrease in production arising from those cuts was partially compensated for by a surge in production in the United States. The market rebalancing sought by these cuts is almost completed, as inventories have almost returned to their five-year average – the reference point underlying the OPEC/non-OPEC agreement on production cuts. Oil demand remains strong, in line with the global business cycle. Non-oil commodity prices have decreased by around 0.8% in US dollar terms since early March. This decline has been driven largely by a fall in the price of iron ore, due to a moderation in Chinese metal imports, and to a lesser extent by a decline in food prices on the back of ample supplies. Aluminium, on the other hand, hit a seven-year high, on the back of concerns over protectionist measures implemented in the United States and of a shutdown in Brazilian production due to an environmental accident.

The outlook for economic activity in the United States remains strong. Real GDP expanded at an annualised rate of 2.9% in the fourth quarter of 2017. Despite the slight deceleration in activity compared with the previous quarter, both consumer spending and business investment increased strongly, although this was partially offset by negative contributions from inventories and net exports. Going forward, the large fiscal expansion, solid labour market conditions and robust foreign demand should continue to support the outlook. In particular, conditions in the labour market remained tight in the first quarter of the year, with the unemployment rate unchanged at 4.1% in March, the labour force participation rate rising to 63% and the annual growth in average hourly earnings standing at 2.7%. In March, annual headline consumer price index (CPI) inflation rose to 2.4%, while, excluding food and energy, inflation increased to 2.1%. Base effects stemming from a considerable fall in mobile phone services prices last year pushed the annual figures significantly higher.

Economic growth moderated in Japan, amid low wage and price pressures. Real GDP increased by 0.4% quarter on quarter in the fourth quarter of 2017, mainly supported by domestic demand. However, contracting industrial production and slowing net exports, together with temporary factors such as unfavourable weather conditions, point to a deceleration in the pace of economic activity in the first quarter of 2018. The labour market remains tight, despite some recent easing in indicators. However, total nominal wages continued to increase moderately. Headline CPI inflation declined to 1.1% in February year on year. At the same time, annual growth in the CPI excluding fresh food and energy – the Bank of Japan’s preferred measure of core inflation – remained stable at 0.5%.

In the United Kingdom, GDP growth slowed slightly during 2017 owing largely to weak private consumption, as inflation rose sharply. Real GDP increased by 0.4% quarter on quarter in the last quarter of 2017, slowing from the previous quarter. Consumption was particularly hard hit, as household spending was constrained in an environment of rising prices and low wage growth. Recent indicators suggest that GDP is likely to remain at more muted rates of growth over the coming quarters than seen before the referendum on EU membership. This is in line with an environment of heightened uncertainty, particularly regarding the outcome of the negotiations with the European Union on the country’s withdrawal in March 2019. At the same time, inflation rose strongly in 2017, peaking at 3.0% in the last quarter, mainly as a result of the pass-through to prices from the marked depreciation in the pound sterling following the referendum. The latest indications are that inflation has now peaked, with annual CPI inflation falling to 2.7% in the first quarter of 2018, following a strong decline in March.

Economic growth in the Chinese economy remains robust. Real GDP grew at 6.8%, in year-on-year terms, in the first quarter of 2018, unchanged from the previous quarter. Growth was driven by both consumption and investment, while the contribution of net trade turned negative. However, overall, momentum in the first quarter of 2018 was weaker than in the last quarter of 2017, consistent with a pattern of weak outcomes in China in the first quarter in recent years. Annual CPI inflation eased to 2.1% in March, from 2.9% in February, as food and non-food prices weakened after the Chinese New Year. Inflation excluding food and energy also slowed to 2.0% in March, from 2.5% in the previous month. At the same time, annual producer price inflation fell to 3.1% in March, as raw material and energy price increases slowed further.


Financial developments

Euro area government bond yields have fallen since early March (see Chart 3). In the period under review (from 8 March to 25 April 2018), the GDP-weighted euro area ten-year sovereign bond yield decreased by 6 basis points, to 1.03%. Despite an interim decline, the German ten-year bond yield now stands unchanged at 0.63%. The initial declines in euro area sovereign rates reflected a softening in euro area macroeconomic data, relative to comparatively high expectations, and also some global spillovers from an intensification of trade disputes and geopolitical tensions. In contrast, vis-à-vis the rate on German ten-year bonds, the yield spreads on Portuguese, Italian and Spanish sovereign bonds continued their downward trajectory amid improvements in country-specific macroeconomic fundamentals in the light of the ongoing economic expansion. In the United Kingdom and the United States, sovereign bond yields increased to 1.54% and 3.03% respectively.

 

Chart 3

Ten-year sovereign bond yields

(percentages per annum)