Economic and monetary developments

Overview

At its monetary policy meeting on 14 June 2018, the Governing Council concluded that progress towards a sustained adjustment in inflation had been substantial so far. Since the start of its asset purchase programme (APP) in January 2015, the Governing Council has made net asset purchases under the APP conditional on the extent of progress towards a sustained adjustment in the path of inflation to levels below, but close to, 2% in the medium term. On 14 June 2018, the Governing Council undertook a careful review of the progress made, also taking into account the latest Eurosystem staff macroeconomic projections, measures of price and wage pressures, and uncertainties surrounding the inflation outlook. As a result of this assessment, the Governing Council concluded that progress towards a sustained adjustment in inflation has been substantial so far. With longer-term inflation expectations well anchored, the underlying strength of the euro area economy and the continuing ample degree of monetary accommodation provide grounds to be confident that the sustained convergence of inflation towards the Governing Council’s aim will continue in the period ahead, and will be maintained even after a gradual winding-down of its net asset purchases. The monetary policy decisions of 14 June 2018 maintain the current ample degree of monetary accommodation that will ensure the continued sustained convergence of inflation towards levels that are below, but close to, 2% over the medium term. Significant monetary policy stimulus is still needed to support the further build-up of domestic price pressures and headline inflation developments over the medium term. This support will continue to be provided by the net asset purchases until the end of the year, by the sizeable stock of acquired assets and the associated reinvestments, and by the Governing Council’s enhanced forward guidance on the key ECB interest rates. In any event, the Governing Council stands ready to adjust all of its instruments as appropriate to ensure that inflation continues to move towards the Governing Council’s inflation aim in a sustained manner.

Economic and monetary assessment at the time of the Governing Council meeting of 14 June 2018

Despite a slight softening of momentum, the near-term global outlook remains essentially solid, supported by accommodative monetary policies in advanced economies and significant fiscal stimulus in the United States. Further ahead, global activity is expected to slow as output is close to potential in many advanced economies. Global trade growth is seen as remaining resilient in the near term. However, the implementation of higher trade tariffs and the possibility of wider protectionist measures represent a key risk to global growth momentum. Global inflationary pressures are expected to rise slowly as spare capacity diminishes.

Since the Governing Council’s meeting in March 2018, euro area long-term risk-free rates have decreased. Sovereign bond spreads have exhibited considerable volatility since the second half of May, against a background of political uncertainty in Italy. The fluctuations in government bond markets have spilled over into other market segments to some extent and stock market volatility has increased. Equity and bond prices of euro area financial corporations have declined, while the impact on other market segments has remained limited. At the same time, stock prices of euro area non-financial corporations have risen, reflecting a robust corporate profit outlook. In foreign exchange markets, the euro has depreciated in nominal effective terms.

The euro area economic expansion remains solid and broad-based across countries and sectors, despite recent weaker than expected data and indicators. Quarterly real GDP growth moderated to 0.4% in the first quarter of 2018, following growth of 0.7% in the previous quarters. This moderation reflects a pull-back from the very high levels of growth in 2017, compounded by an increase in uncertainty and some temporary and supply-side factors at both the domestic and the global level, as well as weaker impetus from external trade. The latest economic indicators and survey results are weaker, but remain consistent with ongoing solid and broad-based economic growth. The ECB’s monetary policy measures, which have facilitated the deleveraging process, continue to underpin domestic demand. Private consumption is supported by ongoing employment gains, which, in turn, partly reflect past labour market reforms, and by growing household wealth. Business investment is fostered by the favourable financing conditions, rising corporate profitability and solid demand. Housing investment remains robust. In addition, the broad-based expansion in global demand is expected to continue, thus providing impetus to euro area exports. The risks surrounding the euro area growth outlook remain broadly balanced. Nevertheless, uncertainties related to global factors, including the threat of increased protectionism, have become more prominent. Moreover, the risk of persistent heightened financial market volatility warrants monitoring.

The June 2018 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 2.1% in 2018, 1.9% in 2019 and 1.7% in 2020. Compared with the March 2018 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised down for 2018 and remains unchanged for 2019 and 2020.

According to Eurostat’s flash estimate, euro area annual HICP inflation increased to 1.9% in May 2018, from 1.2% in April. This reflected higher contributions from energy, food and services price inflation. On the basis of current futures prices for oil, annual rates of headline inflation are likely to hover around the current level for the remainder of the year. While measures of underlying inflation remain generally muted, they have been increasing from earlier lows. Domestic cost pressures are strengthening amid high levels of capacity utilisation, tightening labour markets and rising wages. Uncertainty around the inflation outlook is receding. Looking ahead, underlying inflation is expected to pick up towards the end of the year and thereafter to increase 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.

This assessment is also broadly reflected in the June 2018 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.7% in 2018, 2019 and 2020. Compared with the March 2018 ECB staff macroeconomic projections, the outlook for headline HICP inflation has been revised up notably for 2018 and 2019, mainly reflecting higher oil prices.

The monetary analysis showed broad money growth gradually declining in the context of reduced monthly net asset purchases, with an annual rate of growth of M3 at 3.9% in April 2018, after 3.7% in March and 4.3% in February. While the slower momentum in M3 dynamics over recent months mainly reflects the reduction in the monthly net asset purchases since the beginning of the year, M3 growth continues to be supported by 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, although its annual growth rate has receded in recent months from the high rates previously observed. The pass-through of the monetary policy measures put in place since June 2014 continues to significantly support borrowing conditions for firms and households and credit flows across the euro area. This is also reflected in the results of the latest Survey on the Access to Finance of Enterprises in the euro area, which indicates that small and medium-sized enterprises in particular benefited from improved access to financing.


Monetary policy decisions

Based on the regular economic and monetary analyses, the Governing Council made the following decisions. First, as regards non-standard monetary policy measures, the Governing Council will continue to make net purchases under the APP at the current monthly pace of €30 billion until the end of September 2018. The Governing Council anticipates that, after September 2018, subject to incoming data confirming its medium-term inflation outlook, it will reduce the monthly pace of the net asset purchases to €15 billion until the end of December 2018 and then end net purchases. Second, the Governing Council intends to maintain its policy of reinvesting the principal payments from maturing securities purchased under the APP for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation. Third, the Governing Council decided to keep the key ECB interest rates unchanged and expects them to remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with its current expectations of a sustained adjustment path.


External environment

While the global economic expansion has continued, recent data point to a slight softening of momentum. Global financial conditions have remained supportive but have tightened in some emerging economies. The increase in oil prices, a reflection of still resilient global demand but also concerns about future supply in view of current geopolitical tensions, has dampened prospects in oil-importing economies. Nonetheless, the near-term global outlook remains essentially solid, supported by accommodative monetary policies in advanced economies and significant fiscal stimulus in the United States. Further ahead, global activity is expected to slow, as output is close to potential in many advanced economies. Moreover, although a further recovery in some commodity-exporting economies is envisaged, China’s anticipated transition to a lower growth path should weigh on the outlook. Global inflationary pressures are expected to rise slowly as spare capacity diminishes. Global trade growth is foreseen to remain resilient in the near term. However, the implementation of higher trade tariffs and the possibility of wider protectionist measures represent a key risk to global growth momentum. Indeed, the balance of risks for global activity and trade in the short term has worsened recently, with risks remaining skewed to the downside in the medium term.

Global economic activity and trade

Following a year of strong and highly synchronised growth, global momentum slowed somewhat in the early part of 2018. Data for the first quarter suggest that global activity was slightly weaker than expected. GDP growth in the United States slowed to 0.5%, quarter on quarter, driven by a deceleration in consumer spending, which may have reflected delayed tax refunds and the residual seasonality that has affected first quarter estimates of GDP in recent years. In the United Kingdom growth in activity also moderated, while Japan registered the first quarter-on-quarter fall in GDP in two years. In both cases, adverse weather may have played a role in constraining construction and consumption. By contrast, China’s economy expanded at a robust pace, with GDP growing by 6.8% year on year.

In the near term, the global economic expansion is expected to rebound. Survey data point to sustained growth over the coming quarters. The global composite output Purchasing Managers’ Index (PMI) fell in March but rose in April and May, remaining above the long-run average (see Chart 1). Sentiment indicators also remained upbeat, with consumer confidence close to historical highs.

The implementation of higher trade tariffs, amid ongoing discussions of further protectionist measures, represents a risk to the global economic outlook. In March, President Trump signed an order to impose import tariffs of 25% on steel and 10% on aluminium. While a number of countries were initially exempt, the United States has since decided to extend the tariffs to include the European Union, Canada and Mexico. Affected countries have pledged to increase tariffs in retaliation. The measures implemented so far affect only a small proportion of global trade and are expected to have only a small global macroeconomic effect. However, the risks of further protectionist steps have risen. Following a study of China’s intellectual property practices, the United States threatened to increase tariffs on USD 50 billion of Chinese goods, to which China pledged to retaliate. In addition, the United States launched an investigation into the national security implications of automobile imports. In both cases, nothing had been implemented by the end of the review period. Nonetheless, expectations of an escalation in the dispute could affect investment decisions, with potential effects on global growth. Looking ahead, the risks to global activity from a widespread rise in protectionism could be significant.

 

Chart 1

Global composite output PMI

(diffusion index)

image/svg+xml 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 May 2018. “Long-term average” refers to the period from January 1999 to May 2018.

The global outlook continues to be supported by accommodative but somewhat tighter monetary policies. The Federal Open Market Committee raised interest rates at its March and June 2018 meetings. The Federal Funds futures curve suggests markets continue to anticipate gradual monetary tightening, with at least one more rate hike during 2018 largely priced in by futures markets and a rising probability of two more rate increases this year. Market expectations also suggest a rise in UK rates in the coming months. By contrast, the Bank of Japan still maintains a very accommodative stance. Among emerging market economies, China has continued to see a tightening of domestic financial conditions to tackle risks in the financial system, with interest rates rising again in March – although money market rates have declined moderately in recent weeks. Policy interest rates have also risen in Turkey and Argentina, as the financial environment has deteriorated. However, official rates in Brazil and Russia were cut further in March amid subdued inflationary pressures.

Despite continued monetary accommodation, global financial conditions have tightened in recent weeks, particularly in emerging market economies. Global equity markets have remained fairly resilient, with the Standard & Poor’s 500 still higher than at the start of the year. However, long-term bond yields in major advanced economies have risen. In the United States, the yield on ten-year government bonds has increased by around 50 basis points since the start of the year. The combination of rising interest rates and the strengthening of the US dollar has contributed to tighter financial conditions in emerging market economies. After a sustained recovery over the past year, capital inflows to emerging market economies slowed in April, while the spreads on bonds issued by them widened. At this time, severe financial market volatility has been restricted to a few countries, such as Argentina and Turkey, which markets appear to judge as vulnerable given high rates of inflation and sizeable external financing needs. Nonetheless, financial conditions have tightened for most emerging market economies during this period.

Oil prices have risen sharply in the past two months, although they have seen a moderation more recently. Compared with the early part of this year, the increase has, in part, reflected resilient global demand. At the same time, oil supply has been largely unchanged, as output cuts stemming from the agreement between OPEC members and other oil-producing countries were offset by an increase in production in the United States. Pressure on the spot price rose further in mid‐May, when the United States decided to withdraw from the Joint Comprehensive Plan of Action imposing sanctions on Iran. Subsequently, news that OPEC, Russia and their partners are discussing the possibility of ending the production cuts has driven the price down. Past experience suggests that oil price increases driven by shifts in supply or uncertainties about future supply have tended to be associated with weaker global activity, while demand-driven price increases have, in general, not fully offset the stronger global demand.[1] With the recent oil price increase reflecting both resilient global demand and precautionary effects associated with uncertainty about future supply, the net impact of the higher oil price on the global economy is judged to be modest overall. Nonetheless, the change in oil prices is likely to have some distributional effects across countries, with the outlook for oil exporters strengthening in particular.

Looking ahead, broad-based cyclical momentum is expected to support global activity in the near term. Despite the moderation in activity early in the year, the near-term global outlook remains essentially solid, driven by sound fundamentals. Advanced economies continue to benefit from accommodative monetary policies and, although financial conditions have tightened in recent weeks, they remain supportive for the global economy. A significant fiscal stimulus in the United States, following agreements on tax reform and increased expenditure, is also projected to provide impetus to global growth. The rise in oil prices has slightly dampened prospects in oil-importing economies. By contrast, the improvement in terms of trade is expected to help stabilise investment in many oil-exporting economies as they recover from deep recessions. Moreover, many emerging market economies, particularly China and other export-oriented Asian economies, are benefiting from the tailwinds of the global trade revival.

Over the medium term, however, the positive momentum is expected to slow as cyclical forces wane. Output gaps have already closed in many advanced economies, and spare capacity is expected to contract across emerging market economies in the coming quarters. Moreover, policy support will gradually diminish. In the United States, the boost to growth from the fiscal stimulus is expected to peak in 2019; in Japan, the effects of the fiscal stimulus are expected to fade this year. China’s transition to a lower growth path that is less dependent on credit and fiscal stimulus will also weigh on the global outlook. Over the medium term, the pace of global expansion will settle to below pre-crisis rates.

Turning to developments across countries, in the United States, activity is expected to rebound this year. The upward pressure of tight labour market conditions on wage growth, together with continued improvement in investment and still favourable financial conditions are expected to support domestic demand. Moreover, the fiscal policy changes, including the tax reform and the two-year budget deal, are expected to boost the growth outlook.

In the United Kingdom, economic prospects remain relatively subdued against the background of uncertainties related to the process of the country leaving the European Union. Real GDP growth is expected to rebound modestly after the weak outturn in the first quarter of this year. Thereafter, the outlook is one of moderate growth, as an expected moderation in inflation and a pick-up in wage growth provide some support for private consumption.

In Japan, the economic expansion is projected to decelerate gradually. In the near term, activity is expected to rebound after the weak first-quarter outcome, supported by the accommodative monetary policy stance. Further ahead, growth is projected to decelerate as fiscal support wanes and spare capacity diminishes. Wages are rising moderately in the context of a tightening labour market, which is expected to support household spending and contribute towards a modest increase in inflation.

Economic activity in central and eastern European countries is foreseen to remain robust. GDP growth will be supported by strong investment linked to the absorption of EU funds. In addition, solid consumer spending is projected to be boosted by improvements in the labour market.

In China, activity is projected to decelerate moderately. Output has recently been supported by strong consumption, government support and solid export performance, which have offset the effects of a mild slowdown in housing market activity amid slowing credit growth and tightening financial conditions. Further ahead, the pace of expansion is foreseen to slow gradually, consistent with the emphasis of China’s leadership on accepting slower expansion in order to reduce risks and address imbalances in the economy.

Economic activity is gradually strengthening in the large commodity-exporting countries. In Russia, despite the moderation in the pace of growth in the second half of 2017, the outlook is supported by rising oil prices, declining inflation and improving business and consumer confidence. Over the medium term, economic activity is expected to expand moderately amid the fiscal challenges weighing on the business environment. In Brazil, labour market improvements and continuing monetary accommodation should support consumption, against the backdrop of moderate inflationary pressures. The stabilisation in commodity prices and terms of trade should also be supportive of activity over the forecast horizon. At the same time, political uncertainty and the reversal of previously benign external financial conditions are expected to weigh on demand.

Recent indicators suggest a slight softening of global trade momentum in the near term. According to CPB Netherlands Bureau for Economic Policy Analysis, having risen strongly in January and February, growth in merchandise imports fell to 1.6% in March (in three-month-on-three-month terms). Other indicators have also pointed to a moderation in global trade during the first few months of 2018 (see Chart 2).

 

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 May 2018 (global PMI manufacturing and global PMI new export orders) and March 2018 (trade).

Further ahead, global imports are projected to slow gradually, consistent with the projected cyclical deceleration in global activity. In the past, global trade has exhibited pronounced pro-cyclicality. Recent trade outcomes are consistent with that experience: as global activity recovered in 2015 and 2016, global trade rebounded, rising even faster than global output. Looking ahead, as the global expansion moderates, world trade growth is also foreseen to slow. Over the medium term, trade projections are anchored around the view that global imports will grow broadly in line with activity. This is in line 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. However, risks have increased. In particular, the outlook for trade will depend on how discussions over trade tariffs progress.

Overall, global growth is projected to remain broadly stable over the projection horizon. According to the June 2018 Eurosystem staff macroeconomic projections, world real GDP growth (excluding the euro area) is expected to increase from 3.8% in 2017 to 4.0% in 2018, before declining to 3.9% and 3.7% in 2019 and 2020 respectively. This projection path reflects the expected slowdown in activity in advanced economies and the expected structural slowdown in China, partly offset by a modest gain in dynamism in emerging market economies. Growth in euro area foreign demand is forecast to expand by 5.2% in 2018, 4.3% in 2019 and 3.7% in 2020. Compared with the March 2018 projections, global GDP growth has been revised downwards for 2018 and 2019, reflecting weaker than expected growth in the short term. Growth in euro area foreign demand has been revised upwards slightly over the whole projection horizon, reflecting expectations of more trade-intensive growth in some central and eastern European economies.

The balance of risks for global activity has worsened in recent weeks, with risks judged to be balanced in the short term but skewed to the downside in the medium term. On the upside, the US fiscal package could have a stronger impact on activity than expected. However, the near-term prospects of greater trade protectionism have increased, which could have a significant impact on global activity and trade. Other downside risks relate to the possibility of a further tightening of global financial conditions, disruptions associated with China’s reform process and geopolitical uncertainties associated, in particular, with Brexit-related risks.


Global price developments

Global consumer price inflation has been broadly stable in recent months. In the OECD area, headline inflation rose to 2.3% in April. Excluding food and energy, OECD inflation fell slightly to 1.9% (see Chart 3). At the same time, despite tightening labour markets across advanced economies, wage pressures remain relatively subdued.

Looking ahead, global inflation is expected to rise in the near term. In the short term, inflation is foreseen to increase following the sharp pick-up in oil prices. Later on, however, the current oil futures curve anticipates falling oil prices over the projection horizon, pointing to a negative contribution from energy prices to inflation. However, slowly diminishing spare capacity at the global level is expected to support underlying inflation.

 

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 April 2018.


Financial developments

Since the Governing Council’s meeting in March 2018, euro area long-term risk-free rates have decreased. An uptick in market-based measures of long-term inflation expectations was balanced by a decrease in real rates. Sovereign bond spreads have exhibited considerable volatility since the second half of May, against a background of political uncertainty in Italy. The fluctuations in government bond markets have spilled over into other market segments to some extent and stock market volatility has increased. Equity and bond prices of euro area financial corporations have declined, while the impact on other market segments has remained limited. At the same time, stock prices of euro area non-financial corporations (NFCs) have risen, reflecting a robust corporate profit outlook. In foreign exchange markets, the euro has depreciated in nominal effective terms.

Long-term government bond yields have increased in the euro area and in the United States (see Chart 4). During the period under review (from 8 March to 13 June), the GDP-weighted euro area ten-year sovereign bond yield increased by 11 basis points to 1.20%. Likewise, the ten-year government bond yield in the United States increased by 11 basis points to 2.97%, leaving its spread vis-à-vis the corresponding euro area yield at historically high levels.

 

Chart 4

Ten-year sovereign bond yields

(percentages per annum)