Economic and monetary developments

Overview

At its monetary policy meeting on 13 December, the Governing Council decided to end the net asset purchases in December 2018, while keeping the key ECB interest rates unchanged and enhancing the forward guidance on reinvestment. While incoming information has been weaker than expected, reflecting softer external demand but also some country and sector-specific factors, the underlying strength of domestic demand continues to underpin the euro area expansion and gradually rising inflation pressures. This supports the Governing Council’s confidence that the sustained convergence of inflation to its aim will proceed and will be maintained even after the end of the net asset purchases. At the same time, uncertainties related to geopolitical factors, the threat of protectionism, vulnerabilities in emerging markets and financial market volatility remain prominent. 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. The Governing Council’s forward guidance on the key ECB interest rates, reinforced by the reinvestments of the sizeable stock of acquired assets, continues to provide the necessary degree of monetary accommodation for the sustained convergence of inflation to its aim. 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 inflation aim in a sustained manner.

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

While global economic activity has remained resilient, it has become more uneven and signs of moderating momentum are emerging. The maturing global economic cycle, waning policy support across advanced economies and the impact of tariffs between the United States and China are weighing on global activity. Global trade growth has decelerated somewhat, and uncertainties about future trade relations have risen. At the same time, financial conditions remain accommodative in advanced economies, whereas they have tightened for some emerging markets. Looking ahead, global economic activity is expected to decelerate in 2019 and remain steady thereafter. Global inflationary pressures are expected to rise slowly as spare capacity diminishes.

Long-term risk-free rates have declined in the context of heightened geopolitical uncertainty and a perceived deterioration in the macroeconomic outlook since the Governing Council’s meeting in September 2018. Euro area sovereign bond spreads have been largely stable, with the exception of those for Italy, which have exhibited considerable volatility. Although corporate earnings expectations remain robust, some downward revisions, in addition to a repricing of risk, have led to lower equity and bond prices of euro area corporations. In foreign exchange markets, the euro has broadly weakened in trade-weighted terms.

Euro area real GDP increased by 0.2%, quarter on quarter, in the third quarter of 2018, following growth of 0.4% in the previous two quarters. The latest data and survey results have been weaker than expected, reflecting a diminishing contribution from external demand and some country and sector-specific factors. While some of these factors are likely to unwind, this may suggest some slower growth momentum ahead. At the same time, domestic demand, also backed by the Governing Council’s accommodative monetary policy stance, continues to underpin the economic expansion in the euro area. The strength of the labour market, as reflected in ongoing employment gains and rising wages, still supports private consumption. Moreover, business investment is benefiting from domestic demand, favourable financing conditions and improving balance sheets. Residential investment remains robust. In addition, the expansion in global activity is still expected to continue, supporting euro area exports, although at a slower pace.

This assessment is broadly reflected in the December 2018 Eurosystem staff macroeconomic projections for the euro area. These projections foresee annual real GDP increasing by 1.9% in 2018, 1.7% in 2019, 1.7% in 2020 and 1.5% in 2021. Compared with the September 2018 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised slightly down in 2018 and 2019. The risks surrounding the euro area growth outlook can still be assessed as broadly balanced. However, the balance of risks is moving to the downside owing to the persistence of uncertainties related to geopolitical factors, the threat of protectionism, vulnerabilities in emerging markets and financial market volatility.

According to Eurostat’s flash estimate, euro area annual HICP inflation declined to 2.0% in November 2018, from 2.2% in October. On the basis of current futures prices for oil, headline inflation is likely to decrease over the coming months. Measures of underlying inflation remain generally muted, but domestic cost pressures are continuing to strengthen and broaden amid high levels of capacity utilisation and tightening labour markets, which is pushing up wage growth. Looking ahead, underlying inflation is expected to increase over the medium term, supported by the ECB’s monetary policy measures, the ongoing economic expansion and rising wage growth.

This assessment is also broadly reflected in the December 2018 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.8% in 2018, 1.6% in 2019, 1.7% in 2020 and 1.8% in 2021. Compared with the September 2018 ECB staff macroeconomic projections, the outlook for HICP inflation has been revised slightly up for 2018 and down for 2019. HICP inflation excluding energy and food is expected to rise from 1.0% in 2018 to 1.4% in 2019, 1.6% in 2020 and 1.8% in 2021.

Broad money (M3) growth picked up in October 2018, amid an ongoing shift towards more self-sustained sources of money creation as the monthly net asset purchases under the asset purchase programme were reduced. Lending to the private sector continued to grow and remained the largest driver of broad money growth, albeit with some signs of slowing down, mainly for loans to non-financial corporations. At the same time, bank funding and lending conditions have remained very favourable. 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 euro area general government budget deficit is projected to have declined significantly in 2018 but to increase somewhat next year. The fall in 2018 was mainly the result of favourable cyclical conditions and declining interest payments. The aggregate fiscal stance for the euro area is expected to be broadly neutral in 2018, to loosen in 2019 and 2020, and to turn neutral again in 2021.


Monetary policy decisions

Based on the regular economic and monetary analyses, the Governing Council made the following decisions. 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 decided that net purchases under the asset purchase programme (APP) will end in December 2018. At the same time, the Governing Council enhanced its forward guidance on reinvestment. Accordingly, the Governing Council intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when the Governing Council starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.


External environment

While global economic activity has remained resilient, it has become more uneven and signs of moderating momentum are emerging. The maturing global economic cycle, waning policy support across advanced economies and the impact of tariffs between the United States and China are weighing on global activity. At the same time, financial conditions remain accommodative in advanced economies, while they have remained tight for some emerging markets. Global trade growth has decelerated somewhat, and uncertainties about future trade relations have risen. Looking ahead, global economic activity is expected to decelerate in 2019 and be steady over the following two years, as policy support gradually diminishes and China transitions 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

While global economic activity has remained resilient, signs of moderating momentum are emerging. The global economy continued to expand at a steady pace in the second quarter of 2018, supported by a rebound in activity in several advanced economies, including the United States, the United Kingdom and Japan. The growth rate for the third quarter in the United States still points to resilient activity, while in the United Kingdom GDP growth was strong, partially reflecting an increase in government spending; the Japanese economy contracted in the same period, which was largely due to temporary factors related to natural disasters. Across emerging market economies (EMEs), the growth picture is more mixed. Economic activity held up in China in the third quarter, but weakened substantially in EMEs that had been subject to financial turmoil earlier this year.

Survey-based evidence suggests that activity will decelerate in the near term. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area has been gradually retreating since early 2018, driven mainly by a continued deceleration in global manufacturing activity (Chart 1). The services sector performed better than manufacturing in the year to November, notwithstanding some volatility in the figures. Consumer confidence has recently declined, albeit from high levels.

 

Chart 1

Global composite output PMI

(diffusion indices)

image/svg+xml 48 50 52 54 56 58 2011 2012 2013 2014 2015 2016 2017 2018 Global composite output excluding the euro area Global composite output excluding euro area — long–term average Global manufacturing excluding the euro area Global services excluding the euro area

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

Financial conditions in advanced economies remain accommodative, while the picture for EMEs is relatively mixed. In China, financial conditions have eased owing to action by the People’s Bank of China reacting to the worsening outlook for activity, amid domestic imbalances and rising trade tensions. However, financial conditions in the EMEs that were among the hardest hit by the summer financial market turbulence – including Argentina and Turkey – remain tight and are weighing significantly on their outlook for activity. Overall, global risk sentiment has not fully recovered since the summer months and financial investors have been discriminating against EMEs with significant imbalances, high external financing needs and limited room for policy support. Looking ahead, a further rise in US interest rates as the Federal Open Market Committee proceeds with its gradual policy normalisation, coupled with a stronger dollar, could lead to a further tightening of financial conditions across EMEs.

In the near term, the current cyclical momentum is expected to support global activity. Advanced economies continue to benefit from accommodative monetary policies and supportive financial conditions. A sizeable procyclical fiscal stimulus in the United States, including lower taxes and increased expenditure, will also provide an impetus to global growth, amid a broader shift towards more expansionary fiscal policies among advanced economies.

Looking further ahead, activity is projected to decelerate in 2019 and be steady in the following two years. This reflects the projected cyclical slowdown across advanced economies and in China. Output gaps are already closed in many advanced economies, and spare capacity is expected to narrow across emerging market economies over the medium term. The intensification of trade tensions between the United States and China should weigh on activity in both countries. While the global impact is still judged to be relatively limited, heightened uncertainty about future trade relations may adversely affect confidence and investment. Moreover, policy support is likely to gradually diminish. For the United States, the baseline projection is that the boost to growth from fiscal stimulus will peak in 2019; in Japan fiscal stimulus is already expected to fade this year. On the monetary policy side, a gradual tightening is expected in the United States, as reflected in current financial market prices, and should contribute to a modest tightening of global financial conditions. The expected path for global activity also reflects a recovery in several emerging market economies, especially those affected by the recent financial market turbulence. Overall, the pace of global expansion is expected to settle at rates below those seen before the 2007-08 financial crisis.

Turning to developments across countries, in the United States activity is expected to remain resilient in the near term. Strong labour market conditions, solid corporate profits and still favourable financial conditions should support growth. The procyclical fiscal stimulus will continue to underpin the favourable growth outlook next year, while the bilateral trade conflict with China is expected to weigh somewhat on activity and investment. Moreover, the mid-term elections resulted in split control of Congress, thereby increasing the likelihood of legislative gridlock.

In Japan, activity is expected to rebound in the near term, but the pace of the economic expansion is projected to decelerate gradually thereafter. The adverse impact of a series of natural disasters weighed on activity in the third quarter of 2018, although growth is expected to recover in the fourth quarter. Looking ahead, activity will benefit from accommodative monetary policy, but increasingly binding capacity constraints are expected to weigh on growth. Wages are rising moderately, amid a tight labour market, which should support household spending.

In the United Kingdom, the outlook is for moderate growth, as domestic demand remains subdued. Surprisingly solid activity in the third quarter was supported by several transitory factors. However, high uncertainty continued to weigh on business investment, which extended its decline to three consecutive quarters. The near term outlook remains subject to considerable uncertainty due to the upcoming voting on the EU withdrawal agreement in Parliament.

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.

Activity in China has remained strong, supported by solid consumption, government policy support and robust exports, possibly due in part to frontloading of orders in anticipation of higher tariffs. However, in the near term a slowing housing market and the lagged effects of earlier deleveraging efforts should weigh on growth. Also, new trade tariffs implemented by the US Administration are expected to adversely impact activity. Their overall effect in China is assumed to be relatively contained, though, owing to the recently enacted policy stimulus measures. Over the medium term, progress on the implementation of structural reforms is expected to result in an orderly slowdown and some rebalancing of the Chinese economy.

Economic activity is projected to strengthen in the large commodity-exporting countries. In Russia, the economic recovery is expected to continue, supported by the past increase in oil prices, and improving domestic demand amid rising disposable income and credit. The recent fall in oil prices implies some downside risk to the outlook for the Russia economy. Over the medium term, growth is seen benefiting somewhat from the recently announced multi-year government spending plan. In Brazil, activity is expected to accelerate in the near term, as the impact of political uncertainties and the disruptions from the truckers’ strike fades away. 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. Despite the recent stabilisation of the lira, financial conditions remain tight. Combined with high inflation and procyclical monetary and fiscal policies, this is projected to weigh on economic activity.

Global trade growth has moderated in 2018, following its strong momentum in 2017. The volume of global merchandise imports has been relatively volatile this year. After stalling in the second quarter of 2018, trade increased by 1.5% in the third quarter on account of stronger EME imports. Indicators for subsequent periods provide mixed signals. While the new export order PMI would suggest more underlying weakness in global trade (Chart 2), other indicators – such as global industrial production or the Tech Pulse index – suggest steady growth.

Trade tensions between the United States and China have escalated. The US Administration has announced tariffs targeting an additional USD 200 billion of Chinese exports to the United States, and China has retaliated with tariffs on an additional USD 60 billion of exports from the United States, both effective as of 24 September 2018. This follows previously enacted tariffs targeting USD 50 billion of these countries’ bilateral merchandise trade, as well as tariffs targeting steel and aluminium exports to the Unites States and retaliation by China. These measures are expected to weigh on activity and trade in the United States and China, yet their global impact us expected to remain relatively contained.

 

Chart 2

World trade in goods and surveys

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

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, 1991-2018 (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 September 2018 for global merchandise imports and November 2018 for the PMIs.

Looking ahead, global trade is expected to remain subdued. While the impact of tariffs remains contained so far, it is expected to affect merchandise trade between the United States and China to a larger extent next year. Over the period 2020-21, global trade is projected to grow broadly in line with activity.

Global economic growth is projected to decelerate next year and be steady in the following two years. According to the December 2018 Eurosystem staff macroeconomic projections, world real GDP growth (excluding the euro area) is expected to stand at 3.8% this year before decelerating to 3.5% in 2019. Over the period 2020-21, it is projected to be broadly steady. This projection path reflects the expected slowdown in the near term in some emerging economies, as financial conditions have tightened. Further ahead, the expansion in advanced economies is projected to slow towards potential growth. Moreover, the pace of expansion in China is expected to moderate gradually. Growth in euro area foreign demand is projected to decline from 4.3% this year to 3.1% in 2019, before rising slightly in the medium term. Compared with the September 2018 ECB staff projections, global GDP growth has been revised slightly downwards for 2018 and 2019, reflecting the weaker outlook in some EMEs. Growth in euro area foreign demand has also been revised downwards, for 2019 and 2020, reflecting the effect of higher tariffs and weaker projected economic activity.

Risks for global activity are on the downside. A further escalation of trade disputes could significantly weigh on global growth. While the temporary truce between the United States and China sent a positive signal, there remains considerable uncertainty as to whether the talks will lead to a significant de-escalation of US-China trade tensions. Other downside risks relate to a faster than expected tightening of global financial conditions leading to broader stress in emerging markets, uncertainties regarding China’s reform process, and political and geopolitical uncertainties, including risks related to Brexit.


Global price developments

Although very volatile, oil prices have recently declined significantly. Volatility in the oil price has largely reflected news from the supply side of the market, although, more recently, expectations of lower global demand have weighed on the oil price. The Brent crude oil price peaked at USD 86 per barrel in early October amid expectations of significantly lower oil exports from Iran owing to looming US sanctions and a decision by OPEC and Russia to keep their production steady. Since then, a confluence of positive news on the supply side, including declarations of sufficient spare supply capacity by Saudi Arabia and Russia and the announcement of temporary waivers from US sanctions for several large economies importing oil from Iran, have contributed to an oil price decline. More recently, expectations of lower global demand for oil have also pushed the price down. These developments have meant that the oil price assumption underpinning the December 2018 Eurosystem staff macroeconomic projections was about 5.8% lower for 2019 and 3.2% lower for 2020 than in the previous projections. Since the cut-off date for the projections, however, the price of oil has fallen further, reaching USD 59 per barrel on 12 December.

Before the recent fall in oil prices, past increases put some upward pressure on global consumer price inflation. Annual consumer price index inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) rose to 3.1% in October. Excluding food and energy, inflation was unchanged at 2.3%, pausing on 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 Contribution of all items except food and energy Inflation excluding food and energy Inflation including all items

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

Looking ahead, global inflationary pressures are expected to remain contained. In the short term, the export prices of the euro area’s competitors are expected to increase following the past pick-up in oil prices and higher inflation across several EMEs affected by the summer financial turmoil. Further ahead, the recent decline in oil prices and the current oil futures curve, which suggests gradually declining prices over the medium term, indicate a falling contribution from energy prices to inflation. On the other hand, diminishing spare capacity at the global level is projected to put some upward pressure on inflation.


Financial developments

Since the Governing Council’s meeting in September 2018 global long-term risk-free rates have declined in the context of heightened geopolitical uncertainty and a perceived deterioration in the macroeconomic outlook. Euro area sovereign bond spreads have been largely stable, with the exception of Italy where they have exhibited significant volatility. Although corporate earnings expectations remain robust, some downward revisions, in addition to a repricing of risk, have led to falls in the equity and bond prices of euro area corporations. In foreign exchange markets, the euro has broadly weakened in trade-weighted terms.

Long-term yields have declined in the euro area and in the United States. During the period under review (from 13 September to 12 December 2018), the euro area ten-year risk-free overnight index swap (OIS) rate fell overall to 0.72% (down 4 basis points) and the GDP-weighted euro area ten-year sovereign bond yield fell to 1.09% (down 1 basis point). In the United States (see Chart 4), the ten-year sovereign bond yield fell by 6 basis points to 2.91%, while in the United Kingdom the ten-year sovereign bond yield fell by 22 basis points to 1.28%. Intra-period movements and the overall decline in global long-term yields were driven by heightened geopolitical uncertainty and a number of worse-than-expected macroeconomic data releases.

 

Chart 4

Ten-year sovereign bond yields

(percentages per annum)