Update on economic and monetary developments

Summary

The incoming information that has become available since the Governing Council’s monetary policy meeting in September, while somewhat weaker than expected, remains overall consistent with an ongoing broad-based expansion of the euro area economy and gradually rising inflation pressures. The risks surrounding the euro area growth outlook can still be assessed as broadly balanced. At the same time, risks relating to protectionism, vulnerabilities in emerging markets and financial market volatility remain prominent. Yet, the underlying strength of the economy continues to support 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.

Survey indicators of global economic growth have weakened recently as the global economic cycle matures. The global trade momentum has moderated amid ongoing actions and threats regarding trade tariff increases by the United States and possible retaliation by affected countries, but the near-term outlook remains steady. Global financial conditions remain supportive for advanced economies, while creating headwinds for emerging market economies.

In the euro area, sovereign bond yields have risen amid an increase in global risk-free rates and rising tensions in the sovereign debt markets of some euro area countries. Euro area equity prices have declined, reflecting a deterioration in risk sentiment. By contrast, yield spreads on corporate bonds have remained broadly unchanged. In foreign exchange markets, the euro has been broadly stable in trade-weighted terms.

Euro area real GDP increased by 0.4%, quarter on quarter, in both the first and the second quarter of 2018. Looking ahead, the incoming information remains overall consistent with the Governing Council’s baseline scenario of an ongoing broad-based economic expansion. However, some recent sector-specific developments are having an impact on the near-term growth profile. The ECB’s monetary policy measures continue to underpin domestic demand. Private consumption is fostered by ongoing employment growth and rising wages. Business investment is supported by solid domestic demand, favourable financing conditions and corporate profitability. Housing investment remains robust. In addition, the expansion in global activity is expected to continue supporting euro area exports, though at a slower pace.

Euro area annual HICP inflation increased to 2.1% in September 2018, from 2.0% in August, 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 over the coming months. 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. Looking ahead, underlying inflation is expected to pick up towards the end of the year and to increase further over the medium term, supported by the ECB’s monetary policy measures, the ongoing economic expansion and rising wage growth.

The monetary analysis shows that broad money (M3) growth stood at 3.5% in September 2018, after 3.4% in August. The growth of loans to the private sector has strengthened further, continuing the upward trend observed since the beginning of 2014. The euro area bank lending survey for the third quarter of 2018 indicates that loan growth continues to be supported by increasing demand across all loan categories and favourable bank lending conditions for loans to enterprises and loans for house purchase.

Combining the outcome of the economic analysis with the signals coming from the monetary analysis, the Governing Council concluded 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.

On the basis of this assessment, 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 new monthly pace of €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. 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 of economic growth have weakened recently as the global economic cycle matures. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area declined further below its long-term average in September (see Chart 1), reaching a two-year low. The decline was driven by both the manufacturing and the services components. In quarterly terms, the average PMI for the third quarter of 2018 declined from its level in the previous quarter. The composite output PMI decreased across most advanced economies, including the United States, Japan and the United Kingdom. In emerging market economies, it increased in India but weakened in China, Russia and Brazil, the latter country index remaining below the expansionary threshold.

 

Chart 1

Global composite output PMI

(diffusion index)

48 50 52 54 56 58 2011 2012 2013 2014 2015 2016 2017 2018 Global excluding the euro area Global excluding the euro area – long-term average Advanced economies excluding the euro area Emerging market economies

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

Risks to the global economy remain to the downside, amid ongoing actions and threats regarding trade tariff increases by the United States and possible retaliation by the affected countries. The US administration implemented tariffs targeting an additional USD 200 billion of Chinese imports with effect from 24 September 2018, and China retaliated with tariffs targeting an additional USD 60 billion of exports from the United States. Given the size of these latest measures, uncertainty as to their impact has increased, in particular as regards business sentiment and capital spending plans. Policy uncertainty also remains high. While the United States is weighing additional tariffs on Chinese exports and an expansion of protectionist measures in the automotive sector, a new trade agreement between the United States, Mexico and Canada (USMCA) signals an easing of trade tensions. Overall, the risks to global growth from rising protectionism remain significant.

Global financial conditions remain supportive for advanced economies, while creating headwinds for emerging market economies. Overall, monetary policy in advanced economies remains accommodative. At the same time, in the United States the Federal Open Market Committee increased policy rates in September amid solid growth, rising inflation and a tight labour market. Following the decision, the yield on 10-year US government bonds reached its highest level since 2011, while international equity markets fell sharply. In China, financial conditions eased following action by the People’s Bank of China responding to a weakening outlook for economic activity amid rising trade tensions. More broadly, however, financial conditions in emerging market economies remain tight and weigh on the outlook for economic activity. Overall, global risk sentiment has not fully recovered over the past few months, and financial investors seem to increasingly discriminate against emerging market economies with significant imbalances, high external financing needs and limited room for policy support. Moreover, additional rate increases in the United States and the stronger dollar could lead to a further tightening of financial conditions across emerging market economies.

The global trade momentum has moderated, but the near-term outlook remains steady. Following very weak figures in the second quarter of the year, global merchandise imports further recovered in August on account of stronger imports by emerging market economies (see Chart 2). The global PMI for new export orders decreased to below expansionary territory in September; however, the average for the third quarter of the year remained above the neutral threshold. Other trade indicators give mixed signals. Overall, recent data point to moderate but steady growth in trade in the third quarter.

 

Chart 2

Global trade in goods 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) Average global merchandise imports, 1991-2007 (left-hand scale) Global PMI, manufacturing, excluding the 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 for global merchandise imports and September 2018 for the PMIs.

Global inflation was stable in August. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) was unchanged at 2.9% in August, while inflation excluding food and energy stood at 2.1%. Looking ahead, global inflationary pressures are expected to remain contained. While upward pressures from oil prices should diminish in the medium term, the gradual decline in spare economic capacity is expected to support underlying inflation.

Oil markets have been mainly affected by factors related to the US sanctions against Iran. Brent crude oil prices increased from a low of USD 70 per barrel in the summer to USD 86 per barrel on 3 October as the prospect of the sanctions started to affect Iranian oil exports and OPEC decided not to further increase production. The more recent retreat in oil prices to USD 76 per barrel on October 23 was driven by the announcements by Saudi Arabia and Russia that they could increase output if needed, coupled with a global stock market sell-off and weaker forecasts for oil demand growth. Non-oil commodity prices have decreased by around 2% since end-July. While food prices fell slightly, metal prices increased, mainly on account of iron ore prices.

In the United States, the outlook for economic activity remains solid. Real GDP expanded at an annualised rate of 4.2% in the second quarter of 2018, following 2.2% in the previous quarter. This marked acceleration was due in part to strong exports. To the extent that these exports were front-loaded in response to expected future tariffs, the support from trade is not expected to persist. In addition, the further escalation of trade tensions between the United States and China may increasingly affect business sentiment and thus investment spending. Nonetheless, the near-term outlook remains strong, supported by solid macroeconomic fundamentals, as well as a large procyclical fiscal expansion. Meanwhile, the labour market continued to generate jobs at a robust pace in September, and the unemployment rate declined further to 3.7%, the lowest rate since December 1969. Annual headline consumer price index (CPI) inflation slowed to 2.3% in September, while excluding food and energy, inflation remained at 2.2%.

In Japan, economic activity was robust in the second quarter, but extreme weather conditions have raised uncertainty regarding the outlook. Following a mild contraction in the first quarter of the year, economic activity rebounded in the second quarter, supported by strong investment activity. However, the outlook continues to be surrounded by growing uncertainty. Following the heavy rains and floods in western Japan in July, the impact of Typhoon Jebi and the Hokkaido earthquake in September are likely to weigh on economic activity. Looking further ahead, the Japanese economy is expected to return to moderate growth, albeit at a gradually slowing pace, as declining spare capacity and diminishing fiscal support may limit growth prospects in spite of accommodative monetary policy. In addition, the political uncertainty regarding trade policies remains significant, especially as regards potential tariffs on Japan’s automotive sector. Labour market indicators, meanwhile, point to a further tightening, while upward momentum in prices and wages remains limited. Annual headline CPI inflation stood at 1.2% in September, while CPI inflation excluding food and energy remained close to zero.

In the United Kingdom, real GDP growth rebounded modestly in the second quarter. Real GDP grew by 0.4% quarter on quarter in the second quarter, after first quarter growth was revised down to 0.1%. Household consumption slowed, while the investment and trade expenditure components were revised heavily downwards, revealing contractions in both for two consecutive quarters. The latest PMI survey data suggest quarter-on-quarter GDP growth at a similar rate in the third quarter, though short-term indicators for the export-oriented manufacturing sector signal a less optimistic outlook. This is in line with an environment of moderating global growth, growing trade tensions and the heightened uncertainty surrounding the outcome of the negotiations on the country’s withdrawal from membership of the European Union in March 2019. Having picked up slightly over the course of the summer, inflation fell back to 2.4% in September, from 2.7% in August. The volatility seen over the summer months was in large part expected, reflecting earlier developments in oil prices and a slight weakening in the pound around the end of the second quarter of the year.

In China, GDP growth moderated only slightly in the third quarter of 2018, amid additional policy support. Real GDP grew at 6.5% in year-on-year terms in the third quarter of 2018, supported by strong consumption, government policy support and a solid export performance. However, in the near term a slowing housing market and the lagged effects of earlier financial tightening may weigh on growth. Also, new tariffs implemented by the US administration targeting an additional USD 200 billion of Chinese exports to the United States are expected to adversely impact economic activity. In order to mitigate the impact, the Chinese authorities have announced a broad set of non-tariff measures to facilitate trade growth and foster domestic investment. In addition, Chinese policymakers are set to lower the average tariff rate on imports from 9.8% in 2017 to 7.5% as of 1 November. Headline CPI inflation increased slightly in September to 2.5%, but core inflation declined to 1.7%.


Financial developments

Euro area government bond yields have risen since mid-September (see Chart 3). In the period under review (from 13 September to 24 October 2018), the GDP-weighted euro area ten-year sovereign bond yield rose by 18 basis points to 1.28% amid an increase in global risk-free rates and rising tensions in the sovereign debt markets of some euro area countries. Vis-à-vis the yield on German ten-year government bonds, the spread on ten-year Italian sovereign bonds widened by 86 basis points to 3.22%. The spreads on the equivalent bonds of Spain and Portugal widened to a somewhat lesser extent. Sovereign bond yields increased by 20 basis points to 3.17% in the United States and declined by 3 basis points to 1.48% in the United Kingdom.

 

Chart 3

Ten-year sovereign bond yields

(percentages per annum)