Economic and monetary developments

Overview

At its monetary policy meeting on 13 September, the Governing Council concluded that the incoming information, including the September 2018 ECB staff projections, broadly confirms the Governing Council’s previous assessment of an ongoing broad-based expansion of the euro area economy and gradually rising inflation. The underlying strength of the economy continues to support the Governing Council’s confidence that the sustained convergence of inflation to its aim will proceed and will be maintained even after a gradual winding-down of the net asset purchases. At the same time, uncertainties relating to rising protectionism, vulnerabilities in emerging markets and financial market volatility have gained more prominence recently. Therefore, 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.

Economic and monetary assessment at the time of the Governing Council meeting of 13 September 2018

While the global economy maintained a steady pace in the first half of 2018, momentum is expected to moderate. Advanced economies continue to benefit from accommodative monetary policies and the US fiscal stimulus, while activity among commodity exporters has also been bolstered by the recovery in commodity prices over the past year. However, financial conditions have tightened, particularly for some emerging markets. Moreover, global trade growth has slowed and uncertainties about future trading relations have risen. Over the medium term, global economic activity is expected to expand at a pace close to potential growth, with output gaps already closed or closing in most advanced economies. Global inflationary pressures are expected to rise slowly as spare capacity diminishes.

In financial markets, euro area long-term risk-free rates have been broadly unchanged since the Governing Council’s meeting in June 2018. Sovereign bond spreads have been volatile against a background of sustained political uncertainty in Italy. Although corporate earnings remain robust, equity and bond prices of euro area financial corporations have declined amid geopolitical uncertainty and rising volatility in some emerging markets. In foreign exchange markets, the euro has broadly strengthened in trade-weighted terms.

The latest economic indicators and survey results confirm ongoing broad-based growth of the euro area economy, despite some moderation following the strong growth performance in 2017. Euro area real GDP increased by 0.4%, quarter on quarter, in the second quarter of 2018, the same rate as in the previous quarter. The ECB’s monetary policy measures continue to underpin domestic demand. Private consumption is supported by ongoing employment gains, which, in turn, partly reflect past labour market reforms, and by rising wages. Business investment is fostered by the favourable financing conditions, rising corporate profitability and solid demand. Housing investment remains robust. In addition, the expansion in global activity is expected to continue, supporting euro area exports.

The September 2018 ECB staff macroeconomic projections for the euro area foresee annual real GDP increasing by 2.0% in 2018, 1.8% in 2019 and 1.7% in 2020. Compared with the June 2018 Eurosystem staff macroeconomic projections, the outlook for real GDP growth has been revised down slightly for 2018 and 2019, mainly due to a weaker contribution from foreign demand. Although risks relating to rising protectionism, vulnerabilities in emerging markets and financial market volatility have gained more prominence recently, the risks surrounding the euro area growth outlook can still be assessed as broadly balanced overall.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 2.0% in August 2018, down from 2.1% in July. Looking ahead, on the basis of current futures prices for oil, annual rates of headline inflation are likely to hover around current levels 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, which is pushing up wage growth. 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 and rising wage growth.

This assessment is also broadly reflected in the September 2018 ECB staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.7% in 2018, 2019 and 2020. The outlook for HICP inflation is unchanged compared with the June 2018 Eurosystem staff macroeconomic projections. HICP inflation excluding energy and food is projected to rise gradually from 1.1% in 2018 to 1.5% in 2019 and 1.8% in 2020.

The aggregate fiscal stance for the euro area is projected to be broadly neutral in 2018, mildly expansionary in 2019, and broadly neutral again in 2020. Overall, the euro area budget deficit is expected to decline further over the projection horizon, mainly as a result of favourable cyclical conditions and declining interest payments. Although the euro area government debt-to-GDP ratio will continue to decline, it will remain elevated.

Broad money (M3) growth moderated in the context of reduced monthly net asset purchases under the asset purchase programme (APP). M3 grew by 4.0% in July 2018, after 4.5% in June. Apart from some volatility in monthly flows, M3 growth is increasingly supported by bank credit creation. The narrow monetary aggregate M1 remained the main contributor to broad money growth. The recovery in the growth of loans to the private sector observed since the beginning of 2014 is proceeding. The annual growth rate of loans to non-financial corporations (NFCs) stood at 4.1% in July 2018, while the annual growth rate of loans to households stood at 3.0%, both unchanged from June. The pass-through of the monetary policy measures put in place since June 2014 continues to significantly support borrowing conditions for firms and households, access to financing – in particular for small and medium-sized enterprises – and credit flows across the euro area. The flow of total external financing to euro area NFCs increased considerably in the second quarter of 2018.


Monetary policy decisions

Based on the regular economic and monetary analyses, the Governing Council made the following decisions. First, 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. Second, 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. After September 2018, the monthly pace of the net asset purchases will be reduced to €15 billion until the end of December 2018. The Governing Council anticipates that, subject to incoming data confirming its medium-term inflation outlook, net purchases will then end. Third, 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

While the global economy maintained a steady pace in the first half of 2018, momentum is expected to moderate amid mounting risks and uncertainties related to rising protectionism, vulnerabilities in emerging markets and financial market volatility. Advanced economies continue to benefit from accommodative monetary policies and the US fiscal stimulus, while activity among commodity exporters has also been bolstered by the recovery in commodity prices over the past year. However, financial conditions have tightened, particularly for some emerging markets. Moreover, global trade growth has slowed and uncertainties about future trading relations have risen. Over the medium term, global economic activity is expected to expand at a pace close to potential growth. Output gaps are already closed or closing in most advanced economies, policy support will gradually diminish and China is transitioning to a lower growth path. Global inflationary pressures are expected to rise slowly as spare capacity diminishes. Risks to global activity are skewed to the downside.

Global economic activity and trade

Despite mounting risks and uncertainties, the global economy continued to expand at a steady pace in the first half of 2018. Having moderated in the first quarter, activity growth rebounded strongly in the second quarter in the United States and Japan. GDP growth also recovered modestly in the United Kingdom. Across emerging market economies (EMEs), activity was supported by continued rapid expansion in India and China. Momentum revived in Russia in the first half of this year, buoyed by the rise in oil prices, but weakened in Brazil, where disruptions associated with strikes and political uncertainty hit confidence.

Surveys suggest global activity momentum might moderate somewhat. Global manufacturing has moderated in the past few months and the global composite output Purchasing Managers’ Index (PMI) excluding the euro area declined somewhat below its long-term average in August (Chart 1). However, consumer confidence indicators remain particularly upbeat, despite the recent declines.

 

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 August 2018. “Long-term average” refers to the period from January 1999 to August 2018.

Further tariff increases and uncertainties about future trading relations are likely to weigh on global economic momentum going forward. In the past three months, the United States has enacted further tariff increases. The exemptions that had initially shielded the EU, Canada and Mexico from the tariff increases on steel and aluminium imports expired in June. Affected countries have announced retaliation measures. In addition, tariffs related to Section 301 of the 1974 US Trade Act – directed at concerns about technology transfers to China – took effect in July and August, affecting in total USD 50 billion of Chinese exports to the United States, and China retaliated with tariff increases on a similar value of US exports. Although the tariffs implemented so far affect a relatively small proportion of global trade, tensions over trade are high, which has heightened uncertainty about the outlook. Strains in US‑Chinese trade relations remain, with the US Administration preparing a list of an additional USD 200 billion in imports from China to be targeted in a second round of tariffs, the announcement of which was imminent at the time of the September Governing Council meeting.[1] The United States has also initiated an investigation into auto sector trade to determine its national security implications.

A mix of concerns over trade, the gradual normalisation of monetary policies in advanced economies, and policy uncertainties in some EMEs have led to heightened tensions in financial markets in recent months. The gradual normalisation of monetary policy in the United States has continued: following the interest rate hike in June 2018, the federal funds futures curve suggests that markets anticipate further rate hikes in the coming months. The combination of rising interest rates and the stronger dollar contributed to some tightening of financial conditions across EMEs in the early summer months. Severe tensions have been observed in some EMEs, particularly Argentina and Turkey, reflecting doubts about the credibility of policy as well as high external financing requirements. While acute volatility has been limited to these countries, some spillovers to other vulnerable EMEs have been observed, with sovereign spreads rising and currencies coming under pressure.

In the near term, global economic momentum is expected to moderate. Advanced economies continue to benefit from accommodative monetary policies. A sizeable fiscal stimulus in the United States will also provide an impetus to global growth. Moreover, higher oil prices have helped stabilise investment in many oil exporting economies. However, the slowdown in global trade and rising uncertainty about future trading relations are expected to hit confidence and investment. The tightening of financial conditions in some EMEs in recent months is also expected to weigh on global momentum.

Over the medium term, global economic activity is expected to expand at a pace close to potential growth. Output gaps have already closed in many advanced economies. Moreover, policy support will gradually diminish. China’s transition to a lower growth path that is less dependent on credit and fiscal stimulus will also weigh on global demand. On the other hand, the stabilisation of prospects in EMEs will provide some support for global activity further ahead. Over the medium term, the pace of global expansion is expected to settle at below pre-crisis rates.

Turning to developments across countries, in the United States activity is expected to remain strong this year. Tight labour market conditions, with historically low unemployment levels, stable participation and an upward trend on wage growth, should support household incomes and spending, while solid corporate profits and still favourable financial conditions should bolster investment. Fiscal stimulus from tax reforms and higher expenditure are expected to support the growth outlook this year and next, before fading in 2020.

In Japan, the economic expansion is projected to decelerate gradually. While activity should benefit from accommodative monetary policy, waning fiscal support and increasingly binding capacity constraints are expected to weigh on growth. Wages are rising moderately amid a tightening labour market, which should support household spending. However, inflation is projected to remain below the Bank of Japan’s 2% inflation target.

In the United Kingdom, the outlook is for moderate growth as domestic demand remains subdued. As inflation moderates, private consumption should be supported, despite the uncertain economic outlook. However, uncertainty associated with Brexit negotiations is expected to affect investment in the interim.

In central and eastern European countries, GDP growth is projected to remain robust in the near term. Activity is supported by strong investment linked to EU funds, solid consumer spending and improvements in the labour market. Over the medium term, activity is expected to decelerate towards potential.

Recent data suggest that activity in China is decelerating in the near term. A slowing housing market and the lagged effects of earlier financial tightening may weigh on growth, while higher tariffs imposed by the United States are expected to weigh on trade. However, monetary accommodation and some fiscal support should help to sustain activity growth in the near term. Over the medium term, it is assumed that continued progress on structural reforms would lead to an orderly slowdown and some rebalancing of the Chinese economy.

Economic activity is projected to strengthen moderately in the large commodity-exporting countries. In Russia, the outlook is supported by the rise in oil prices this year, relatively low inflation and improving business and consumer confidence. On the other hand, the recently imposed US sanctions are likely to weigh on near-term growth owing to increased political uncertainties. Over the medium term, economic activity is expected to expand moderately amid a challenging business environment, weak fixed investment and a lack of structural reforms, which is undermining Russia’s growth potential. In Brazil, the short-term outlook is affected by political uncertainties and the disruptions from strikes. However, further ahead an improved labour market and continuing monetary accommodation should support consumption, as inflationary pressures remain contained.

Turkey is expected to undergo a difficult adjustment in the coming months. Rapid economic growth over the past year has led to substantial overheating. The recent depreciation of the currency, amid capital outflows and high inflationary pressures, signals a rapid deterioration in the economic environment. Indicators already point to a softening of activity, which is expected to deepen in the near term.

After strong growth in 2017, global trade indicators point to a deceleration in the first half of this year. According to CPB data, the volume of merchandise imports fell by 0.4% in June (in three-month-on-three-month terms). The picture of softening global trade is consistent with other indicators (Chart 2).

 

Chart 2

World trade in goods

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

image/svg+xml 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 August 2018 (global PMI manufacturing and global PMI new export orders) and June 2018 (trade).

In the near term, global trade is expected to remain subdued. Increased trade protectionism is expected to weigh on trade prospects. The tariffs implemented so far affect a relatively small proportion of global trade. However, while the direct trade effects of the tariff increases are small for most countries, they have heightened concerns about the broader outlook for trade policies and the global economy. This uncertainty about future trading relations is expected to hit confidence and investment, which will also weigh on global trade prospects. Over the medium term, global trade is projected to grow broadly in line with activity.

Overall, global growth is projected to decelerate over the projection horizon. According to the September 2018 ECB staff macroeconomic projections, world real GDP growth (excluding the euro area) is expected to increase to 3.9% in 2018, before declining to 3.7% in 2019 and 2020. This projection path reflects the expected slowdown in the near term in some emerging economies, as financial conditions have tightened. Further ahead, expansion in advanced economies is projected to slow towards potential growth. At the same time, the pace of expansion in China is expected to moderate gradually. Growth in euro area foreign demand is forecast to stand at 4.1% in 2018, before declining to 3.6% in 2019 and 2020. Compared with the June 2018 projections, global GDP growth has been revised downwards for 2018 and 2019, reflecting the weaker outlook in some EMEs. Growth in euro area foreign demand has also been revised downwards, reflecting the reduced momentum observed in trade data as well as the effects of weaker projected activity.

The balance of risks for global activity is skewed to the downside. 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 remain high, 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, particularly for EMEs, disruptions associated with China’s reform process and geopolitical uncertainties associated, in particular, with Brexit-related risks.


Global price developments

Oil prices have been volatile in recent weeks. During the early summer months, oil prices declined as supply prospects improved with the cessation of disruptions in Libya and the prospect of increased supplies from OPEC and Russia. That meant that the oil price assumption underpinning the September ECB staff macroeconomic projections was about 7.5% lower in the short term than it had been in the previous projection. Since the cut-off date for the projections, however, the price of oil has risen again, reaching USD 80 per barrel on 12 September. The latest increase reflected market reaction to lower-than-expected crude oil inventories in the United States, which suggested a faster tightening of the market than had been expected.

The past increase in oil prices has put upward pressure on global consumer price inflation. In the OECD area, consumer price index (CPI) inflation rose to 2.9% in July. Excluding food and energy, inflation increased slightly to 2.1%, extending a very moderate upward trend observed over the past year (Chart 3). At the same time, despite tightening labour markets across advanced economies, wage pressures remain relatively subdued.

 

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

Sources: OECD and ECB staff calculations.
Note: The latest observation is for July 2018.

Looking ahead, global inflationary pressures are expected to remain contained. In the short term, the euro area’s competitors’ export prices are expected to increase following the recent pick up in oil prices. Further ahead, however, the current oil futures curve anticipates a modest decline in oil prices, implying a declining contribution from energy prices to global inflation. On the other hand, diminishing spare capacity at the global level is projected to provide some upward support for inflation.


Financial developments

Since the Governing Council’s meeting in June 2018, euro area long-term risk-free rates have remained broadly unchanged. Sovereign bond spreads have been volatile against a background of sustained political uncertainty in Italy. Although corporate earnings remain robust, equity and bond prices of euro area financial corporations have declined amid geopolitical uncertainty and rising volatility in emerging markets. In foreign exchange markets, the euro has broadly strengthened in trade-weighted terms.

Long-term yields remain broadly unchanged in the euro area and in the United States. During the period under review (from 14 June to 12 September), the euro area ten-year risk-free overnight index swap (OIS) rate and the GDP-weighted euro area ten-year sovereign bond yield remained unchanged at 0.75% and 1.10%, respectively. In the United States the ten-year government bond yield increased by 3 basis points to 2.96%, causing its spread vis-à-vis the corresponding euro area yield to increase further and reach historically high levels.

 

Chart 4

Ten-year sovereign bond yields

(percentages per annum)