Update on economic and monetary developments

Summary

The incoming information that has become available since the Governing Council’s decision to end net asset purchases in December 2018 has continued to be weaker than expected on account of softer external demand and some country and sector-specific factors. In particular, the persistence of uncertainties relating to geopolitical factors and the threat of protectionism is weighing on economic sentiment.

At the same time, supportive financing conditions, favourable labour market dynamics and rising wage growth continue to underpin the euro area expansion and gradually rising inflation pressures. This underlying strength of the economy supports the Governing Council’s confidence in the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. Nevertheless, significant monetary policy stimulus remains essential to support the further build-up of domestic price pressures and headline inflation developments over the medium term. This will be provided by the Governing Council’s forward guidance on the key ECB interest rates, reinforced by the reinvestments of the sizeable stock of acquired assets. The Governing Council confirmed that it 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.

The global economic growth momentum has slowed recently amid geopolitical uncertainties and vulnerabilities in emerging markets. Global trade decelerated towards the end of 2018 as downside risks related to unresolved trade disputes remained prominent and growth in emerging markets slowed down. While financial conditions are favourable overall, the weaker global growth momentum has fuelled stock market volatility. A more accommodative monetary policy stance has been taken in China in the light of the slowing growth momentum.

Euro area government bond yields declined somewhat as global risk-free rates decreased and sovereign bond spreads in the euro area remained stable. Despite heightened intra-period volatility, equity prices in the euro area stayed, overall, broadly unchanged. Similarly, yield spreads on corporate bonds increased only modestly. In foreign exchange markets, the euro depreciated 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. Incoming data have continued to be weaker than expected resulting from a slowdown in external demand which was compounded by several country and sector-specific factors. While the impact of some of these factors is expected to fade, the near-term growth momentum is likely to be weaker than previously anticipated. Looking ahead, the euro area expansion will continue to be supported by favourable financing conditions, further employment gains and rising wages, lower energy prices, and the ongoing – albeit somewhat slower – expansion in global activity.

Euro area annual HICP inflation declined to 1.6% in December 2018, from 1.9% in November, reflecting mainly lower energy price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline further over the coming months. Measures of underlying inflation remain generally muted, but labour cost pressures are continuing to strengthen and broaden amid high levels of capacity utilisation and tightening labour markets. 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.

Overall, the risks surrounding the euro area growth outlook have moved to the downside on account of the persistence of uncertainties related to geopolitical factors and the threat of protectionism, vulnerabilities in emerging markets and financial market volatility.

The monetary analysis shows that broad money (M3) growth decreased to 3.7% in November 2018, after 3.9% in October. M3 growth continues to be backed by bank credit creation. The narrow monetary aggregate M1 remained the main contributor to broad money growth. The annual growth rate of loans to non-financial corporations stood at 4.0% in November 2018, after 3.9% in October, while the annual growth rate of loans to households remained broadly unchanged at 3.3%. The euro area bank lending survey for the fourth quarter of 2018 suggests that overall bank lending conditions remained favourable, following an extended period of net easing, and demand for bank credit continued to rise, thereby underpinning loan growth.

The outcome of the economic analysis and the signals coming from the monetary analysis 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.

Based on 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 reinvest, in full, the principal payments from maturing securities purchased under the asset purchase programme 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

Economic indicators signal a moderation in global growth momentum. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area weakened in late 2018 (see Chart 1), mainly owing to a continued deceleration in global manufacturing activity. The services sector remained more resilient than manufacturing, notwithstanding some volatility in the figures. Consumer confidence has declined recently, albeit from high levels.

 

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

Downside risks to global activity have been increasing and a further escalation of trade disputes could weigh on global growth. While the postponement of further tariff increases by the United States and China has sent a positive signal, considerable uncertainty remains as to whether the negotiations will lead to a significant de-escalation of US-Chinese trade tensions. Other downside risks relate to a faster tightening of global financial conditions and broader stress in emerging markets, uncertainties regarding China’s economic prospects, as well as political and geopolitical uncertainties, including risks related to Brexit.

Financial conditions remain accommodative overall, while concerns over US and global economic activity have fuelled stock market volatility. In China, fiscal policy and monetary policy have eased in response to a weakening, in particular, of the manufacturing sector. Market expectations of further interest rate increases in the United States have eased somewhat, amid a further decline in Treasury yields, partly reflecting developments in term premia. Looking ahead, the Federal Open Market Committee (FOMC) is proceeding with its gradual policy normalisation, albeit against a more cautious economic outlook and a slightly lower interest rate path projection.

Global trade momentum decelerated towards the end of 2018. Global merchandise imports weakened in October, while in December the global PMI for new export orders pointed, for the fourth consecutive month, to a contraction (see Chart 2). High frequency trade data for China weakened considerably towards the end of 2018, possibly signalling that the trade tensions between the United States and China are affecting manufacturing sentiment in both economies and are adversely impacting global trade growth.

 

Chart 2

Surveys and global 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) Average global merchandise imports, 1991-2018 (left-hand scale) Global PMI, manufacturing output, 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 October 2018 for global merchandise imports and December 2018 for the PMIs.

Global inflation slowed in November. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) moderated to 2.7% in November, largely as a result of easing energy prices, while inflation excluding food and energy decreased marginally to 2.2%. Global inflationary pressures are expected to remain contained. Wage growth in advanced economies continues to be moderate, despite a tightening of labour markets and rising capacity constraints.

Oil markets have remained broadly stable. Oil prices declined in the fourth quarter of 2018, mainly on account of oversupply fears related to the waivers on the US sanctions on Iranian oil exports, coupled with continued high production growth in the United States. These effects initially outweighed the possible price effects of production cuts by OPEC and a group of allied oil-producing nations, particularly because market uncertainty persisted regarding the cuts agreed on 7 December 2018. However, prices recovered after data releases indicated lower than expected production levels, and Brent crude oil prices stood at USD 61 per barrel on 22 January. Non-oil commodity prices have increased slightly, mainly on the back of food price increases.

The US economy recorded strong growth in 2018, in the context of a pro-cyclical fiscal stimulus, but lower confidence and weaker than expected data have clouded the growth outlook. Real GDP growth expanded at an annualised rate of 3.4% in the third quarter of 2018 – well above potential – albeit slowing from 4.2% in the previous quarter on the back of declining net exports and decelerating private fixed investment. The US government shutdown has added to the uncertainty generated by US trade policy in respect of China and is (temporarily) weighing on US economic activity in the near term. Headline consumer price inflation declined to 1.9% in November due to a sharp deceleration in energy prices, while average hourly earnings remained strong. Against this background, the FOMC raised the federal funds rate target range at its December 2018 meeting by 25 basis points, as expected, and slightly lowered its projections for GDP growth and core inflation for the next years.

In Japan, real GDP for the fourth quarter of 2018 is set to return to positive growth, but inflation remains weak. Volatility in GDP in 2018 was mainly due to the impact of natural disasters and extreme weather conditions. Looking ahead, the economy is expected to remain on a moderate growth path, supported by highly accommodative monetary policy and the domestic capital expenditure cycle. The reflation momentum in the economy has weakened, with inflation excluding energy and food declining marginally due to the recent softening of oil prices and the appreciation of the yen.

In the United Kingdom, growth looks set to decline after a robust outturn in the third quarter of 2018. The strong quarter-on-quarter growth of 0.6% in the third quarter reflected a temporary boost to consumption and public investment, as well as a strong rebound in exports. However, business investment fell for the third consecutive quarter. Overall, activity is expected to remain muted in the medium term. Annual CPI inflation decreased slightly to 2.1% in December, resulting in a fourth quarter average of 2.3%, following strong declines in previous months.

The Chinese economy is losing growth momentum, with the manufacturing sector in particular showing signs of weakening. In December 2018, the manufacturing PMI dropped below 50 for the first time since 2017, while the services sector – less exposed to the US trade tensions – was more resilient. The People’s Bank of China enacted new policies to cushion the slowdown, including a 100-basis point reduction in the required reserve ratio in early January and a new lending facility to support small firms in December. New fiscal policy measures are also expected, although fiscal spending by local governments may face constraints. Annual headline CPI inflation fell to 1.9% in December, reflecting a lower contribution from non-food items, while core inflation remained steady. Producer price index inflation decelerated sharply to 0.9% in the same month in response to lower oil and commodity prices, and also to the slowdown in Chinese manufacturing activity.


Financial developments

Long-term yields have declined in the euro area and in the United States. During the period under review (from 13 December 2018 to 23 January 2019), the GDP-weighted euro area ten-year sovereign bond yield fell to 0.98% (down 9 basis points) as global risk-free rates decreased and intra-period financial market volatility increased (see Chart 3). In the United States, the ten-year sovereign bond yield fell by 16 basis points to 2.74%, while in the United Kingdom the ten-year sovereign bond yield rose by 2 basis points to 1.33%.

 

Chart 3

Ten-year sovereign bond yields

(percentages per annum)