Update on economic and monetary developments

Summary

The information that has become available since the Governing Council’s monetary policy meeting on 14 June indicates that the euro area economy is proceeding along a solid and broad-based growth path.[1] Uncertainties related to global factors, notably the threat of protectionism, remain prominent, and the risk of persistent heightened financial market volatility continues to warrant monitoring. However, the risks surrounding the euro area growth outlook can still be assessed as broadly balanced. The underlying strength of the economy has confirmed the Governing Council’s confidence that the sustained convergence of inflation to its aim will continue in the period ahead and will be maintained even after a gradual winding-down of the net asset purchases. Nevertheless, 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 its aim in a sustained manner.

The growth momentum of the global economy continued to be steady in the second quarter of 2018, but downside risks related to trade tariffs have remained prominent. In addition, global trade indicators recorded a loss in momentum. Financial conditions have tightened somewhat for emerging market economies, but overall remain supportive in advanced economies.

In the euro area, sovereign bond yields have declined since the 14 June meeting, on the back of receding volatility in sovereign debt markets and declining risk-free rates. Equity prices experienced a correction amid increasing trade tensions. In foreign exchange markets, the euro broadly appreciated in trade‑weighted terms.

The latest economic indicators have stabilised and continue to point to ongoing solid and broad-based growth, albeit at a slower pace than in 2017. This easing reflects a pull-back from the very high levels of growth last year and is related mainly to weaker impetus from previously very strong external trade, compounded by an increase in uncertainty and some temporary and supply-side factors at both the domestic and the global level. Private consumption continues to be 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.

Euro area annual HICP inflation increased to 2.0% in June, from 1.9% in May, reflecting mainly higher energy and food 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 and broadening amid high levels of capacity utilisation and tightening labour markets. 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.

The monetary analysis indicates that broad money growth increased again in June 2018, having gradually decelerated since it last peaked in September 2017. The recovery in the growth of loans to the private sector is proceeding, driven mainly by loans to non-financial corporations (NFCs). The euro area bank lending survey for the second quarter of 2018 suggests that loan growth continued to be supported by easing credit standards and increasing demand across all loan categories. Net issuance of debt securities by euro area NFCs is estimated to have increased further, while financing costs for NFCs have remained favourable.

On the basis of the outcome of the economic analysis and the signals coming from the monetary analysis, the Governing Council confirmed that an ample degree of monetary accommodation is still necessary for the continued sustained convergence of inflation to levels that are below, but close to, 2% 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 at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. Regarding non-standard monetary policy measures, the Governing Council confirmed that the Eurosystem will continue to make net purchases under the asset purchase programme (APP) at the current monthly pace of €30 billion until the end of September 2018. The Governing Council anticipates that, after September, 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. Furthermore, the Governing Council intends to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of the net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.


External environment

Global survey indicators continue to signal a steady growth momentum for the second quarter of 2018. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area increased slightly further in June (see Chart 1), reaching a four-month high, as the continued pick-up in the services sector more than compensated for the moderate decline in manufacturing. In quarterly terms, the PMI in the second quarter of 2018 was slightly above the average in the previous quarter. The composite output PMI in June decreased moderately in the United States from May, while it strengthened in Japan and in the United Kingdom. In emerging market economies, the composite output PMI increased in June in China and bounced back considerably in India, while the rate of expansion slowed in Russia and Brazil.

 

Chart 1

Global composite output PMI

(diffusion index)

48 50 52 54 56 58 60 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 calculations.
Notes: The latest observations are for June 2018. “Long-term average” refers to the period from January 1999 to June 2018.

At the same time downside risks to the global economy have intensified, amid actions and threats regarding trade tariff increases by the United States and possible retaliation by the affected countries. The first wave of US tariffs on Chinese imports took effect on 6 July and further US tariffs are planned. The Chinese authorities revealed their intention to introduce retaliatory measures. Simultaneously, retaliatory measures by the European Union and Canada against the tariffs previously imposed on steel and aluminium came into force. The US administration also initiated a new investigation into imports of cars and spare parts for cars, which, should it result in protectionist measures, could particularly affect Canada, Japan, Mexico and South Korea as well as key economies in the European Union. Complex supply chains could further amplify the adverse effects of protectionism on the world economy. Overall, if all the threatened measures were to be implemented, the average US tariff rate would rise to levels not seen in the last 50 years. These developments constitute a serious risk to the outlook for global trade and activity in the short to medium term.

Global financial conditions remain supportive overall, but have tightened somewhat for emerging market economies. Overall, monetary policy in advanced economies remains accommodative. In the United States, the Federal Open Market Committee increased policy rates in line with expectations in June. Against the backdrop of increasing inflation and tighter labour market conditions, officials at the Federal Reserve System also revised up the path of the federal funds rate to four total hikes in 2018, from the three previously expected. Renewed global trade tensions and the appreciation in the US dollar resulted in somewhat tighter financing conditions for emerging market economies. In China, stock prices also declined and the renminbi faced some depreciation pressures. On the whole, volatility in global equity markets increased and stock prices of automotive and technological sectors came under downward pressures. Central bank interest rates have been maintained in the United Kingdom, and the Bank of Japan is holding ten-year yields close to zero in line with its yield curve control programme. Among emerging market economies, Russia and Brazil have kept rates unchanged in recent months, while Turkey and Argentina hiked rates substantially in May and June amid significant financial market tensions. China has continued to tighten domestic financial conditions to tackle risks in the financial system.

Global trade indicators recorded a loss in momentum. Monthly trade data decelerated significantly and broadly across countries. Global merchandise imports contracted in April and May 2018, reversing the strong growth recorded in the first quarter, and the global PMI for new export orders fell in the five months to June (see Chart 2). Other trade indicators have also weakened, including measures related to global value chains. Overall, these indicators point to a deceleration in trade in the second quarter of 2018.

 

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) 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 for global merchandise imports and June 2018 for PMIs.

Global inflation edged up in May. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) increased to 2.6% in May. The rise was driven by energy prices, while food prices slowed slightly. Excluding food and energy prices, OECD annual inflation increased marginally to 2%. Inflation is expected to continue rising in the near term following the pick-up in oil prices. Looking further ahead, the gradual decline in spare capacity is also expected to support underlying inflation.

Oil prices have remained broadly stable amid some volatility. Brent crude oil prices increased gradually from around USD 75 per barrel in mid-June to USD 78 per barrel on 10 July, before falling to USD 73 per barrel on 20 July. The effect on oil prices from the announcement by the Organization of the Petroleum Exporting Countries (OPEC) on 22 June of its intention to increase supply has been relatively muted to date. While markets had anticipated an output rise of one million barrels per day, capacity constraints in many OPEC countries suggest a smaller rise in oil supply in the near term. In addition, in July, oil prices were buoyed by strong global oil demand, ongoing geopolitical tensions involving Iran, and political turmoil in Venezuela and in Libya. More recently oil prices have decreased slightly. Non-oil commodity prices have decreased by around 8% since mid-June, with food prices falling by 8% and metal prices dropping by 9%. Food prices fell owing to ample supplies on the back of favourable weather conditions in North America and concerns about rising protectionist threats also affecting food commodities, particularly soybeans. The fall in metal prices can be partly explained by lower demand in China and concerns about a possible trade war.

The outlook for economic activity in the United States remains solid, but concerns about tariffs have arisen among firms. Real GDP expanded at an annualised rate of 2% in the first quarter of 2018. Despite the slight deceleration in activity, the near-term US outlook remains strong, supported by solid fundamentals as well as the large and procyclical fiscal expansion. In particular, consumer confidence is at cyclical highs, and tax cuts should further support domestic demand, even if the recent increase in petrol prices might mitigate somewhat the positive effects of the fiscal expansion. At the same time, anecdotal evidence from regional manufacturing surveys suggest that US businesses are concerned about the impact of a possible further escalation of trade tensions, which may affect their investment spending. The labour market continued to generate jobs at a solid pace and indicators continue to point to tightness, while wage growth remains moderate. Annual headline consumer price index (CPI) inflation reached its highest level since 2012, rising to 2.9% in June, while increasing to 2.3% when food and energy are excluded.

In Japan, the economy is expected to recover from a mild contraction in the first quarter of 2018, but the outlook is surrounded by growing uncertainty. Economic indicators suggest that positive growth in activity resumed in the second quarter, recovering from the first contraction of GDP in two years. However, the outlook is surrounded by growing uncertainty. The intense rainfall in western Japan in early July is expected to weigh on economic activity, as several large manufacturers had to shut down their plants amid the severely damaged infrastructure in the region. In addition, a further escalation of trade tensions could significantly hit the Japanese economy, especially if tariffs are increased on imports of cars and their spare parts, which account for around a third of Japan’s exports to the United States. A further tightening of the labour market seems to be inducing a transition to more secure jobs, amid gradually accelerating base wages and still subdued inflation. Annual headline CPI inflation remained stable at 0.7% in June, yet underlying inflation remained low, with CPI excluding food and energy at 0%.

In the United Kingdom, the weakening in GDP growth over the first quarter of 2018 is considered to be temporary. The third GDP growth release for the first quarter posted a 0.1 percentage point upward revision to 0.2%, mainly due to the upward revision of the net trade component, which also led to a further narrowing of the United Kingdom’s trade deficit. The latest PMI and monthly GDP numbers suggest a rebound in UK GDP in the second quarter, but short-term indicators for the export-oriented manufacturing sector signal a less optimistic outlook. This is in line with an environment of heightened uncertainty, particularly regarding the outcome of the negotiations on the country’s withdrawal from membership of the European Union in March 2019. Inflation stabilised at 2.4% in May, unchanged from April, as movements in the exchange rate have helped offset recent increases in oil prices.

In China, GDP growth moderated slightly in the second quarter of 2018 while financial markets recorded downward pressures. Real GDP grew at 6.7% in year-on-year terms in the second quarter of 2018, in line with market expectations of a slowdown in economic activity. The ongoing structural deleveraging campaign has so far been focused on the banking sector, but it is starting to filter through to the broader economy and is affecting investment patterns. Infrastructure investment in particular fell as financing channels tightened, although investment in manufacturing and real estate rebounded (see the box entitled “Imbalances in China: is growth in peril from a housing market downturn?” in this issue of the Economic Bulletin). Chinese equities and foreign exchange markets have been under pressure recently, reflecting both fears of an escalation of trade tensions and a slowdown in growth. Price pressures picked up in June, with annual headline CPI inflation rising to 1.9%.


Financial developments

Euro area government bond yields have fallen since late June (see Chart 3). In the period under review (from 14 June to 25 July 2018), the GDP-weighted euro area ten-year sovereign bond yield decreased by 7 basis points to 1.04% amid receding tensions in the sovereign debt markets and declining risk-free rates. Vis-à-vis the yield on German ten-year government bonds, the spreads on Italian, Portuguese and French sovereign bonds declined. Long-term sovereign bond yields decreased to 1.27% in the United Kingdom and increased slightly to 2.98% in the United States.

 

Chart 3

Ten-year sovereign bond yields

(percentages per annum)