Economic and monetary developments

Overview

Based on a thorough assessment of the economic and inflation outlook, the Governing Council took a series of monetary policy decisions at its monetary policy meeting on 7 March. The weakening in economic data points to a sizeable moderation in the pace of the economic expansion that will extend into the current year, even though there are signs that some of the idiosyncratic domestic factors dampening growth are starting to fade. The persistence of uncertainties related to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets appears to be leaving marks on economic sentiment. Moreover, underlying inflation continues to be muted. The weaker economic momentum is slowing the adjustment of inflation towards the Governing Council’s aim. 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. Against this background, the Governing Council decided to adjust its forward guidance on the key ECB interest rates to indicate its expectation that they will “remain at their present levels at least through the end 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”, as well as to reiterate its forward guidance on reinvestments. Furthermore, the Governing Council decided to launch a new series of targeted longer-term refinancing operations (TLTRO-III) and to continue conducting all lending operations as fixed rate tender procedures with full allotment at least until the end of the reserve maintenance period starting in March 2021. These decisions were taken to ensure that inflation remains on a sustained path towards levels that are below, but close to, 2% over the medium term.

Economic and monetary assessment at the time of the Governing Council meeting of 7 March 2019

Global growth momentum continued to moderate in late 2018. Global growth is projected to decelerate in 2019, but to stabilise over the medium term. The slowdown has been more pronounced in the manufacturing sector, with global trade decelerating sharply as a result. Heightened global uncertainties relating to trade disputes, the financial stress in emerging market economies last summer and signs of weaker growth in China have contributed to the slowdown in global growth and trade. While those headwinds are expected to continue to weigh on the global economy this year, recent economic policy measures are expected to provide some support. Global trade is expected to weaken more significantly this year and to grow in line with activity in the medium term. Global inflationary pressures are expected to remain contained, while downside risks to global activity have been accumulating.

Long-term risk-free rates have declined since the Governing Council’s meeting in December 2018, in the context of a deterioration in the macroeconomic outlook and a perceived slowing of the pace of monetary tightening in the United States. The prices of euro area risk assets such as equities and corporate bonds have recovered amid improved risk sentiment, fuelled in part by greater optimism regarding global trade negotiations. In foreign exchange markets, the euro has broadly weakened in trade-weighted terms.

Euro area real GDP growth remained subdued in the fourth quarter of 2018 at 0.2% quarter on quarter. Incoming information suggests that growth will continue at moderate rates in the near term. Data releases have continued to be weak, in particular in the manufacturing sector, reflecting the slowdown in external demand compounded by some country and sector-specific factors. The impact of these factors is turning out to be somewhat longer-lasting, which suggests that the near-term growth outlook will be weaker than previously anticipated. Looking ahead, the effect of these adverse factors is expected to unwind. The euro area expansion will continue to be supported by favourable financing conditions, further employment gains and rising wages, and the ongoing – albeit somewhat slower – expansion in global activity.

This assessment is broadly reflected in the March 2019 ECB staff macroeconomic projections for the euro area. These projections foresee annual real GDP increasing by 1.1% in 2019, 1.6% in 2020 and 1.5% in 2021. Compared with the December 2018 Eurosystem staff macroeconomic projections, the outlook for real GDP growth has been revised down substantially in 2019 and slightly in 2020. The risks surrounding the euro area growth outlook are still tilted to the downside, on account of the persistence of uncertainties related to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets.

According to Eurostat’s flash estimate, euro area annual HICP inflation increased to 1.5% in February 2019, from 1.4% in January. On the basis of current futures prices for oil, headline inflation is likely to remain at around current levels before declining towards the end of year. Measures of underlying inflation have remained generally muted, but labour cost pressures have strengthened and broadened amid high levels of capacity utilisation and tightening labour markets. Looking ahead, underlying inflation is expected to increase gradually 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 March 2019 ECB staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.2% in 2019, 1.5% in 2020 and 1.6% in 2021. Compared with the December 2018 Eurosystem staff macroeconomic projections, the outlook for HICP inflation has been revised down across the projection horizon, reflecting in particular the more subdued near-term growth outlook. Annual HICP inflation excluding energy and food is expected to be 1.2% in 2019, 1.4% in 2020 and 1.6% in 2021.

Money growth and credit dynamics moderated in January 2019, but bank funding and lending conditions remained favourable. Broad money (M3) growth decreased to 3.8% in January 2019, from 4.1% in December 2018. M3 growth continues to be backed by bank credit creation, notwithstanding a recent moderation in credit dynamics. The annual growth rate of loans to non-financial corporations declined to 3.3% in January 2019, from 3.9% in December 2018, reflecting a base effect but also, in some countries, the typical lagged reaction to the slowdown in economic activity, while the annual growth rate of loans to households remained stable at 3.2%. Borrowing conditions for firms and households are still favourable, as the monetary policy measures put in place since June 2014 continue to support access to financing, in particular for small and medium-sized enterprises. The Governing Council’s decisions, in particular the new series of TLTROs, will help to ensure that bank lending conditions remain favourable going forward.

The aggregate fiscal stance for the euro area is assessed to have been broadly neutral in 2018, but is projected to be mildly expansionary from 2019 onwards. This is mainly the result of a loosening fiscal stance in a less favourable macroeconomic environment.


Monetary policy decisions

Based on the regular economic and monetary analyses, the Governing Council made the following decisions:

  • First, the key ECB interest rates were kept unchanged. The Governing Council now expects the key ECB interest rates to remain at their present levels at least through the end 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 intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time past the date when it 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.
  • Third, the Governing Council decided to launch a new series of quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years. These new operations will help to preserve favourable bank lending conditions and the smooth transmission of monetary policy. Under TLTRO-III, counterparties will be entitled to borrow up to 30% of the stock of eligible loans as at 28 February 2019 at a rate indexed to the interest rate on the main refinancing operations over the life of each operation. Like the outstanding TLTRO-II programme, TLTRO-III will feature built-in incentives for credit conditions to remain favourable. Further details on the precise terms of TLTRO-III will be communicated in due course.
  • Fourth, the Governing Council decided to conduct the Eurosystem’s lending operations as fixed rate tender procedures with full allotment for as long as necessary, and at least until the end of the reserve maintenance period starting in March 2021.

The Governing Council took these decisions to ensure that inflation remains on a sustained path towards levels that are below, but close to, 2% over the medium term. The decisions will support the further build-up of domestic price pressures and headline inflation developments over the medium term. 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.


External environment

Global growth momentum continued to moderate in late 2018, and surveys suggest that it has weakened further in early 2019. The slowdown has been more pronounced in the manufacturing sector, with global trade decelerating sharply as a result. Heightened global uncertainties relating to the trade dispute between the United States and China, the financial stress that was seen in emerging market economies last summer and, more recently, signs of weaker growth in China have all contributed to the slowdown in global growth and trade. While those headwinds are expected to continue to weigh on the global economy this year, recent economic policy measures are expected to provide some support. As a result, global growth is projected to decrease in 2019, but to stabilise over the medium term. Global trade is expected to weaken more significantly this year and to grow in line with activity in the medium term. Global inflationary pressures are expected to remain contained, while downside risks to global activity have been accumulating.

Global economic activity and trade

Global growth momentum moderated further in late 2018. Economic activity in advanced economies weakened in the fourth quarter of 2018, with growth slowing in both the United States and the United Kingdom. While growth in Japan strengthened in that quarter, this followed a contraction in the previous quarter on account of a series of natural disasters. Growth in emerging market economies (EMEs) also weakened in late 2018 – including in China.

Survey-based evidence suggests that growth has continued to weaken in early 2019. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area has continued to decline, owing mainly to weakening global manufacturing activity. Service sector activity has also moderated recently, although its decline has been weaker and from a higher level (see Chart 1). Global manufacturing activity has slowed against the backdrop of maturing business cycles in key advanced economies. At the same time, the pace of this slowdown has been accentuated by heightened uncertainties weighing on the global economy, such as the lingering trade dispute between the United States and China, the financial stress that was seen in EMEs last summer and, more recently, signs of weaker growth in China. The slowdown in global manufacturing activity is also weighing on global trade.

 

Chart 1

Global composite output PMI

(diffusion indices)

48 50 52 54 56 58 2012 2013 2014 2015 2016 2017 2018 2019 Global composite output excluding the euro area Global composite output excluding the euro area – long-term average Global manufacturing output excluding the euro area Global services excluding the euro area

Sources: Markit and ECB calculations.
Notes: The latest observations are for February 2019. “Long-term average” refers to the period from January 1999 to January 2019.

Financial conditions in advanced economies remain accommodative overall, while the picture for EMEs remains mixed. Market expectations of further interest rate increases in the United States have eased amid a further decline in Treasury yields, partly reflecting developments in term premia. In China, financial conditions have also eased as policymakers have adopted a looser monetary policy stance in response to indications of weakening activity. Following a sharp decline at the end of 2018 against the backdrop of renewed concerns about the global economy, global stock prices have rebounded since the turn of the year. However, global risk sentiment has not yet fully recovered, and volatility in financial markets remains elevated. In some of the EMEs that were hardest hit by the financial market turbulence last summer – including Argentina and Turkey – financial conditions remain relatively tight and are continuing to weigh on activity.

Global growth is projected to soften this year amid increasing headwinds. These include weaker global manufacturing activity and trade in an environment of high and rising political and policy uncertainty. The sizeable procyclical fiscal stimulus in the United States (which includes tax cuts and increased spending) is continuing to help drive US and global growth, but the partial federal government shutdown, which ended in late January, is expected to weigh on growth in the first quarter of 2019. In China, domestic demand is expected to weaken in the first half of this year, as the impact of recently implemented policies is likely to kick in with something of a lag.

Looking further ahead, global growth is projected to stabilise over the medium term. Three key forces look set to shape the global economy over the projection horizon. First, cyclical momentum is expected to slow in key advanced economies as capacity constraints become increasingly restrictive and policy support gradually diminishes amid positive output gaps and low unemployment rates. Second, China is expected to continue its orderly transition to a weaker growth path that is less dependent on investment and exports. And finally, growth is forecast to recover in several key EMEs which are currently going through, or have recently experienced, deep recessions. Overall, the pace of global expansion is expected to settle at rates below those seen prior to the 2007-08 financial crisis.

Turning to developments in individual countries, activity in the United States has remained relatively robust. The country’s strong labour market, favourable financial conditions and fiscal stimulus are continuing to support growth, outweighing the adverse impact of the trade dispute with China. The negative impact of the partial federal government shutdown is expected to be temporary. Annual headline consumer price inflation fell to 1.6% in January from 1.9% in the previous month, largely on account of falling energy prices, while consumer price inflation excluding food and energy remained unchanged at 2.2%.

In Japan, recovering domestic demand supported growth in late 2018. This recovery followed a sharp contraction in the third quarter on account of a series of natural disasters. Looking ahead, the country’s accommodative monetary policy stance, its strong labour market and its robust demand for investment (despite a weakening external environment) are all projected to support growth. In addition, fiscal measures are expected to smooth out the negative impact of the consumption tax increase that is scheduled for October of this year. The fact that wage growth remains modest (despite a very tight labour market) and inflation expectations are at low levels suggests that inflation will remain below the Bank of Japan’s 2% target over the medium term.

In the United Kingdom, heightened political uncertainty is continuing to weigh on growth. Even the short-term outlook is subject to considerable uncertainty as a result of the forthcoming votes on the EU withdrawal agreement in parliament. Over the medium term, growth is expected to remain below its pre-referendum trajectory.

In central and eastern European countries, growth is projected to moderate somewhat this year. Investment growth remains strong, supported by EU funds, and consumer spending also remains robust, underpinned by strong labour market performance. However, the slowdown in the euro area is weighing on the growth outlook for this region. Over the medium term, growth levels in these countries are expected to fall back towards potential.

Growth in China has lost some of its momentum in recent months. Moreover, monthly indicators suggest that this trend is likely to continue in early 2019. In order to shield the economy from a sharper slowdown, the Chinese authorities have announced a number of fiscal and monetary policy measures, which are expected to deliver a smooth deceleration in activity this year. Looking further ahead, progress with the implementation of structural reforms is projected to result in an orderly transition to a more moderate growth path that is less dependent on investment and exports.

Economic activity in large commodity-exporting countries is projected to gradually strengthen. The outlook for growth in Russia is shaped by developments in global oil markets, and past declines in oil prices are projected to weigh on activity this year. Looking further ahead, economic activity in Russia is expected to gradually strengthen, amid constraints imposed by international sanctions and uncertainty relating to the implementation of structural reforms and spending commitments announced last year. Growth in Brazil is also projected to strengthen, supported by accommodative financial conditions and declining political uncertainty.

In Turkey, economic activity contracted significantly in the third quarter of 2018 as a result of the legacy of last summer’s financial turmoil, high inflation and procyclical monetary and fiscal policies. Following a strong adjustment in late 2018, growth is projected to resume later this year and gradually rise thereafter.

Global trade growth moderated last year amid significant volatility, with a strong performance being recorded in the first half of 2018, followed by a relatively sharp deceleration. That slowdown reflects weakening global manufacturing activity, heightened trade tensions and, more recently, a significant deterioration in trade in Asia – particularly in China. According to CPB data, the volume of global merchandise imports fell by 1.2% in December in three-month-on-three-month terms, signalling a further weakening of global trade momentum in the fourth quarter of 2018 (see Chart 2). Moreover, incoming data indicate that global trade growth has remained weak in the first quarter of 2019.

A temporary truce agreed between the United States and China in December 2018 put a further escalation of trade tensions on hold. Tariffs on USD 200 billion of Chinese exports to the United States had originally been set to rise from 10% to 25% as of 1 January 2019, but that increase was put on hold as a result of the agreed truce. While this sent a positive signal, there remains considerable uncertainty as to whether the ongoing trade negotiations will lead to a significant de-escalation of trade tensions. Meanwhile, President Trump has recently announced that the truce is to be extended, citing progress achieved in those trade negotiations, which means that the increase in tariff rates remains on hold. A formal trade agreement between the United States and China is currently expected to be signed in late March. Risks remain, however, as trade tensions could intensify again and the US administration could impose new tariffs on imports from other countries.

 

Chart 2

Surveys and global trade in goods

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

44 46 48 50 52 54 56 58 60 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 2012 2013 2014 2015 2016 2017 2018 2019 Global merchandise imports (left-hand scale) Average global merchandise imports, 1991-2018 (left-hand scale) Global PMI, manufacturing output (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 relate to February 2019 for the PMIs and December 2018 for global merchandise imports.

Following a robust performance last year, global economic growth is projected to weaken this year, before stabilising over the medium term. According to the March 2019 ECB staff macroeconomic projections, global real GDP growth (excluding the euro area) is projected to fall to 3.5% this year, down from 3.7% in 2018. This reflects increasing headwinds to global growth, such as weaker global manufacturing activity in an environment of high and rising political and policy uncertainty. Over the period 2020-21, it is then projected to stabilise at around 3.6% as a result of a slowdown in key advanced economies, China’s transition to a weaker growth path and an expected pick-up in growth in several key EMEs. As a result of global growth headwinds weighing significantly on global trade, growth in euro area foreign demand is projected to slow significantly this year, falling to 2.2%, down from 4.0% in 2018. In the medium term, euro area foreign demand is expected to grow in line with activity, as the impact of the heightened political and policy uncertainty is expected to gradually dissipate. Compared with the December 2018 Eurosystem staff macroeconomic projections, global GDP growth has been revised slightly downwards for this year. Meanwhile, growth in euro area foreign demand has been revised significantly downwards for this year and slightly downwards for next year. These revisions reflect disappointing data releases in late 2018, coupled with projected declines in demand for imports in China and the rest of emerging Asia, as well as in European economies outside the euro area.

Downside risks to global activity have been accumulating. Despite the temporary truce between the United States and China, tail risks stemming from an intensification of global trade tensions remain high. A sharper slowdown in China’s economy might be more difficult to address using policy stimulus, which will also pose challenges in the context of the country’s ongoing rebalancing process. Meanwhile, a “no deal” Brexit scenario could have highly adverse spillover effects, especially in Europe, and elevated geopolitical uncertainties could weigh on global growth. Finally, some EMEs remain vulnerable to the reversal of capital flows, though the risk of significant numbers of EMEs suffering acute stress has recently subsided.


Global price developments

Oil prices have remained highly volatile. In the final quarter of 2018, oil prices declined amid assurances by Saudi Arabia and Russia that they would offset the effect on oil supply of the US sanctions against Iran. That downward pressure then intensified, with the US government granting temporary waivers for key importers of Iranian oil and US crude oil production standing at a high level amid renewed concerns about the global economy. Oil prices then recovered somewhat at the turn of the year as the OPEC+ agreement to cut production took effect, amid unexpectedly high levels of compliance by the various member countries. Looking ahead, oil prices are expected to remain broadly stable at this lower trajectory over the projection horizon. Consequently, the oil price assumptions underpinning the March 2019 ECB staff macroeconomic projections were around 8.6% lower for this year (and 8.2% and 8.0% lower for 2020 and 2021 respectively) relative to assumptions underpinning the December 2018 Eurosystem staff macroeconomic projections. Since the cut-off date for the March projections, however, the price of oil has increased further, standing slightly above USD 65 per barrel on 6 March.

Global inflationary pressures remain contained. In countries belonging to the Organisation for Economic Co-operation and Development (OECD), annual headline consumer price inflation averaged 2.4% in December 2018, down from 2.7% in the previous month, owing to a decline in the contribution of the energy component (see Chart 3). Underlying inflation (excluding food and energy) was also down slightly on the previous month, standing at 2.2%. Tight labour market conditions across major advanced economies have so far translated into moderate wage increases, and the pace of underlying inflation remains subdued. Past declines in oil prices are expected to weigh on headline inflation going forward.

 

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 2012 2013 2014 2015 2016 2017 2018 2019 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 observations are for January 2019.

Looking ahead, global inflationary pressures are expected to remain contained. Growth in the export prices of the euro area’s competitors is expected to weaken sharply this year and remain steady over the medium term. This reflects a declining positive contribution from the oil price, which is projected to turn negative in the near term and will thus outweigh the upward pressures on underlying inflation stemming from diminishing spare capacity at the global level.


Financial developments

Since the Governing Council’s meeting in December 2018, global long-term risk-free rates have declined in the context of a deterioration in the macroeconomic outlook and a perceived slowing of the pace of monetary tightening in the United States. The prices of euro area risk assets, such as equities and corporate bonds, have recovered amid improved risk sentiment, fuelled in part by a greater sense of optimism regarding global trade negotiations. In foreign exchange markets, the euro has broadly weakened in trade-weighted terms.

Long-term yields have declined in both the euro area and the United States. During the period under review (13 December 2018 to 6 March 2019), the euro area ten-year risk-free overnight index swap (OIS) rate fell to 0.48% (down 23 basis points) and the GDP-weighted euro area ten-year sovereign bond yield (see Chart 4) fell to 0.84% (down 23 basis points). In the United States, the ten-year sovereign bond yield fell by 22 basis points over that period to stand at 2.71%, while the equivalent yield in the United Kingdom fell 8 basis points to stand at 1.22%. Global long-term yields fell following communications from the Federal Reserve System which were interpreted by the markets as signalling a slower intended pace of monetary policy tightening. In addition to possible spillovers from the United States, euro area bond yields also reflected a deterioration in the macroeconomic outlook following a number of worse than expected macroeconomic data releases, as well as some reappraisal of the monetary policy outlook for the euro area as signalled by the short end of the yield curve.

 

Chart 4

Ten-year sovereign bond yields

(percentages per annum; daily data)