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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)

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)

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)

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)

Sources: Thomson Reuters and ECB calculations.
Notes: The vertical grey line denotes the start of the review period on 13 December 2018. The latest observations are for 6 March 2019.

Euro area sovereign bond spreads relative to the risk-free OIS rate remained broadly unchanged over the review period. Conditions in sovereign bond markets were largely stable throughout that period, with the exception of the Italian market, where the ten-year spread remained volatile (although it recovered to 2.11 percentage points at the end of the review period; see Chart 5). Consequently, the spread between the GDP-weighted average of euro area ten-year sovereign bond yields and the ten‑year OIS rate remained stable over the review period, standing at 0.36 percentage points on 6 March.

 

Chart 5

Ten-year euro area sovereign bond spreads vis-à-vis the OIS rate

(percentage points per annum)

Sources: Thomson Reuters and ECB calculations.
Notes: The spread is calculated by subtracting the ten-year OIS rate from the ten-year sovereign bond yield. The vertical grey line denotes the start of the review period on 13 December 2018. The latest observations are for 6 March 2019.

The euro overnight index average (EONIA) averaged ‑0.37% over the review period. Excess liquidity was broadly unchanged at around €1,890 billion. For further details of developments in liquidity conditions, see Box 2.

The EONIA forward curve shifted downwards somewhat over the review period. The curve is now below zero for all horizons prior to 2022, reflecting market expectations of a prolonged period of negative interest rates (see Chart 6).

 

Chart 6

EONIA forward rates

(percentages per annum)

Sources: Thomson Reuters and ECB calculations.

Broad indices of euro area equity prices increased over the review period amid a general improvement in risk sentiment. The equity prices of euro area banks and non-financial corporations (NFCs) increased by around 7% over the period (with similar increases being observed in the United States), reversing a large percentage of the declines seen in the fourth quarter of 2018 (see Chart 7). That recovery in equity prices reflected a greater sense of optimism regarding the outlook for global trade and was underpinned by communications from the Federal Reserve System which were interpreted by the markets as signalling a slowdown in the intended pace of monetary policy tightening. At the same time, both short and longer-term corporate earnings expectations were revised downwards over the review period, reflecting a perceived deterioration in the macroeconomic outlook for the euro area.

 

Chart 7

Euro area and US equity price indices

(index: 1 January 2015 = 100)

Sources: Thomson Reuters and ECB calculations.
Notes: The vertical grey line denotes the start of the review period on 13 December 2018. The latest observations are for 6 March 2019.

Euro area corporate bond spreads declined over the review period, largely reflecting an improvement in risk sentiment. Since December the spread between the yield on investment-grade NFC bonds and the risk-free rate has declined by around 14 basis points to stand at 78 basis points (see Chart 8). Yields on financial sector debt have also declined, resulting in the relevant spread falling by around 18 basis points. Despite these recent declines, both spreads remain above the levels observed a year ago.

 

Chart 8

Euro area corporate bond spreads

(basis points)

Sources: iBoxx indices and ECB calculations.
Notes: The vertical grey line denotes the start of the review period on 13 December 2018. The latest observations are for 6 March 2019.

In foreign exchange markets, the euro broadly depreciated in trade-weighted terms over the review period (see Chart 9). Indeed, the nominal effective exchange rate of the euro, as measured against the currencies of 38 of the euro area’s most important trading partners, fell by 1.2% over that period. In bilateral terms, the euro weakened against most currencies. In particular, the euro depreciated slightly against the US dollar (by 0.6%) and weakened against most other major currencies, including the pound sterling (by 4.3%), the Japanese yen (by 2.1%) and the Chinese renminbi (by 3.1%). The euro also depreciated vis-à-vis the currencies of most emerging markets, while it appreciated against the currencies of most EU Member States outside the euro area.

 

Chart 9

Changes in the exchange rate of the euro vis-à-vis selected currencies

(percentage changes)

Source: ECB.
Notes: “EER-38” is the nominal effective exchange rate of the euro against the currencies of 38 of the euro area’s most important trading partners. All changes have been calculated using the foreign exchange rates prevailing on 6 March 2019.

Economic activity

Euro area real GDP growth remained subdued in the fourth quarter of 2018 at 0.2% quarter on quarter, driven by a contraction in the industrial sector. Incoming data suggest that growth will continue at moderate rates in the near term. Looking ahead the expansion of the euro area economy is expected to continue, supported by favourable financing conditions, further employment gains and rising wages, as well as the ongoing, albeit somewhat slower, expansion in global activity. The March 2019 ECB staff macroeconomic projections for the euro area expect annual real GDP to increase 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 downwards substantially for 2019 and slightly for 2020.

Growth in the euro area continued at a slow pace in the fourth quarter of 2018. While weak growth mainly reflected a contraction in the industrial sector, it remained resilient overall. Real GDP increased by 0.2%, quarter on quarter, in the fourth quarter of last year, slightly above the rate in the previous quarter (see Chart 10). Subdued growth in the fourth quarter was driven by a sharp contraction in the industrial sector, while services continued to exhibit stronger dynamics. Domestic demand and net trade made positive contributions to growth, increasing by 0.4% and 0.2% respectively, while changes in inventories had a dampening effect, decreasing by 0.4%. Overall, output growth in the fourth quarter led to a yearly rise in GDP of 1.8% in 2018, down from 2.4% in the previous year.

 

Chart 10

Euro area real GDP, the Economic Sentiment Indicator and the composite output Purchasing Managers' Index

(quarter-on-quarter percentage growth; diffusion index)

Sources: Markit, European Commission and Eurostat.
Notes: The Economic Sentiment Indicator (ESI) is standardised and rescaled to have the same mean and standard deviation as the Purchasing Managers’ Index (PMI). The latest observations are for the fourth quarter of 2018 for real GDP and February 2019 for the ESI and the PMI.

Employment continued to increase in the fourth quarter of 2018, rising by 0.3% quarter on quarter (see Chart 11). Most euro area countries saw an increase in employment, which was broadly based across sectors. Currently, the level of employment stands close to 3.0% above the pre-crisis peak recorded in the first quarter of 2008. Taking into account the latest increase, there has been cumulative growth in employment in the euro area, with 10 million more persons in employment than at the time of the trough in the second quarter of 2013. Continued employment growth combined with a drop in GDP growth in 2018 has led to a moderation in productivity growth, following a modest pick-up in 2017. Empirically, adjustments in employment tend to lag behind declines in output. One reason is that longer-term employment contracts cannot be adjusted immediately when firms face a slowdown in demand.

Recent short-term labour market indicators continue to point to positive but moderating employment growth in the first quarter of 2019. The euro area unemployment rate stood at 7.8% in January 2019, unchanged from December 2018, and remains at its lowest level since October 2008. Survey indicators point to a further slowdown in employment growth in the first quarter of 2019.

 

Chart 11

Euro area employment, PMI assessment of employment and unemployment

(quarter-on-quarter percentage changes; diffusion index; percentages of the labour force)

Sources: Eurostat, Markit and ECB calculations.
Notes: The Purchasing Managers' Index (PMI) is expressed as a deviation from 50 divided by 10. The latest observations are for the fourth quarter of 2018 for employment, February 2019 for the PMI and January 2019 for the unemployment rate.

Private consumption growth edged up in the fourth quarter of 2018 and is expected to regain further momentum in the quarters ahead, as temporary dampening effects wane in an environment of continued strengthening of households’ labour income. Private consumption increased by 0.2%, quarter on quarter, in the fourth quarter of 2018, following somewhat weaker growth in the third quarter. The weakness in household expenditure partly reflected temporary bottlenecks in the car sector, affecting the consumption of durable goods, and the negative effect of energy price increases on household purchasing power. The crude oil price (in euro) increased from the fourth quarter of 2017 to the third quarter of 2018, which negatively affected consumption growth, in particular of non-durable goods, i.e. food and energy. Subsequently, the oil price declined sharply (before recovering somewhat in the last two months). This should support consumption of non-durable goods in the near term. Furthermore, employment growth strengthened in the fourth quarter of 2018 in an environment of robust wage increases. This implies steady growth in households’ real disposable income and supports consumer confidence and spending. In addition, while financing conditions remain very favourable, households’ net worth improved at a strong rate in the third quarter of 2018.

Latest indicators also suggest some strengthening of private consumption momentum in the course of the year ahead. Recent data on retail sales and car registrations indicate moderate but steady growth in consumer spending. The volume of retail sales increased by 1.4% in January 2019, following a drop in the previous month. As a result, sales stood at 1.5% above their average level in the fourth quarter of 2018. The indicator for new passenger car registrations posted its fourth consecutive increase in January 2019, rising by 4.8% on a monthly basis. This confirms previous expectations for a normalisation in car registrations, following the volatile developments triggered by the introduction of the new Worldwide Harmonised Light Vehicle Test Procedure (WLTP) on 1 September 2018. In addition, consumer confidence increased for a second consecutive month in February, halting the declining trend observed throughout most of 2018. The latest improvement reflects households’ more benign views regarding their past and future financial situation, as well as the expected general economic situation and unemployment. Consumer confidence remains above its historical average level and is consistent with ongoing steady growth in private consumption.

The ongoing recovery in housing markets is also expected to continue, albeit at a slower pace than in 2018. Housing investment increased by 0.6% in the fourth quarter of 2018, reflecting the ongoing recovery in many euro area countries and in the euro area as a whole. Although growth over 2018 was slower than the buoyant growth experienced in 2017, it remains at solid, healthy levels. In line with these developments, recent short-term indicators and survey results point to positive, but slowing momentum. Construction production in the buildings segment increased by 0.2%, quarter on quarter, in the fourth quarter of 2018, recovering from -0.8% in the third quarter. The European Commission’s construction confidence indicators for the past few months point to positive, albeit weakening, momentum in the fourth quarter of 2018 and early 2019. The Purchasing Managers’ Index (PMI) for housing activity averaged 52.0 in the last quarter of 2018, but decreased to 50.6 in January 2019. However, both the PMI indicators and the European Commission’s confidence indicators remain clearly above their long-run averages.

Business investment in the euro area appears to have lost some momentum in the second half of 2018, but fundamentals remain supportive. Available country data for some of the larger euro area countries point overall to a slowdown in business investment growth in the fourth quarter of 2018. The slowdown in business investment partly reflects heightened policy uncertainty and financial volatility in some euro area countries. Persistent concerns about global trade developments, the possibility of a no-deal Brexit and economic weaknesses in China also appear to have adversely affected business confidence. The assessment of export order books and production expectations in the capital goods sector continued to worsen in January and February 2019. However, fundamentals remain supportive of business investment. First, capacity utilisation remains well above its long-term average, and a large share of manufacturing firms report lack of equipment as a factor limiting production. Second, the ECB’s monetary policy measures continue to support favourable financing conditions and access to financing for euro area firms. Third, during the recent period of recovery, firms have also used profits to build up a sizeable liquidity overhang.

Euro area trade in goods continued to grow at a subdued pace at the end of 2018 and is expected to decline further in the near term. According to the latest release of data from the national accounts, in the last quarter of 2018 total euro area exports increased by 0.9%, while imports increased by 0.5% on a quarterly basis. Incoming data on the monthly trade in goods confirm a poor performance by total euro area trade in the fourth quarter, mostly driven by intra-euro area trade. In December 2018 nominal euro area exports contracted by 0.5%, month on month, with intra-euro area exports decreasing even more (by 0.9%). Nominal euro area imports saw a slight month-on-month increase of 0.4%. Temporary factors, such as the new regulations on vehicle emissions tests, have weighed on exports. However, a generalised decrease can be observed across all product categories. The United Kingdom, Turkey and China continue to drive the weakness in extra-euro area exports observed in the last few months of 2018. Looking ahead leading indicators point to a further reduction in extra-euro area exports in the coming months. In February 2019 the manufacturing PMI for new export orders outside of the euro area was at its lowest since November 2012 (46.4), and the European Commission’s assessment went more negative compared with January.

The latest survey results have continued to disappoint and suggest that euro area growth is moderating in the short term. The European Commission’s Economic Sentiment Indicator remained broadly unchanged in February, standing above its long-term average. So far in 2019 the average stands at 106.2, below the 108.9 average for the last quarter of 2018. Although the indicator declined for the industry and construction sectors, this was broadly offset by positive sentiment in services, the retail sector and households. The composite output PMI increased slightly in February, but the average for the first two months of the first quarter of 2019 stood below that for the previous quarter (51.4 compared with 52.3).

Despite the current slowdown, over the medium term the broad-based economic expansion is expected to regain traction and to continue over the period ahead. The ECB’s accommodative monetary policy continues to strengthen domestic demand. Ongoing growth in employment and wages should keep private consumption high. At the same time business investment is supported by healthy domestic demand, favourable financing conditions and improving balance sheets, and housing investment remains strong.

The March 2019 ECB staff macroeconomic projections for the euro area forecast annual real GDP to increase by 1.1% in 2019, 1.6% in 2020 and 1.5% in 2021 (see Chart 12). Compared with the December 2018 Eurosystem staff projections, the outlook for real GDP growth has been revised downwards substantially for 2019 and slightly for 2020. The risks surrounding the euro area outlook remain tilted to the downside.

 

Chart 12

Euro area real GDP (including projections)

(quarter-on-quarter percentage changes)

Sources: Eurostat and the article entitled “March 2019 ECB staff macroeconomic projections for the euro area”, published on the ECB’s website on 7 March 2019.
Notes: The ranges shown around the central projections are based on the differences between actual outcomes and previous projections carried out over a number of years. The width of the range is twice the average absolute value of these differences. The method used for calculating the ranges, involving a correction for exceptional events, is documented in the “New procedure for constructing Eurosystem and ECB staff projection ranges”, ECB, December 2009.

Prices and costs

According to Eurostat’s flash estimate, euro area annual HICP inflation increased to 1.5% in February 2019, up from 1.4% in January. While measures of underlying inflation continued to move sideways, domestic cost pressures 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 – revised downwards 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.

Headline inflation increased in February owing to stronger price increases in volatile categories. According to Eurostat’s flash estimate, euro area annual HICP inflation increased to 1.5% in February 2019, up from 1.4% in January (see Chart 13). This reflected higher inflation rates for the more volatile categories, energy and food, while HICP inflation excluding energy and food (HICPX) declined. The higher inflation rate for energy reflected upward base effects and a moderate increase in oil prices (in euro terms). When discussing HICP data since January 2019, one should note that two methodological changes have been introduced that imply revisions to the historical data (see Box 4 “New features in the Harmonised Index of Consumer Prices: analytical groups, scanner data and web-scraping” and Box 5 “A new method for the package holiday price index in Germany and its impact on HICP inflation rates”).

 

Chart 13

Contributions of components to euro area headline HICP inflation

(annual percentage changes; percentage point contributions)

Sources: Eurostat and ECB calculations.
Notes: The latest observations are for February 2019 (flash estimates). Growth rates for 2015 are distorted upwards owing to a methodological change (see Box 5 in this issue of the ECB’s Economic Bulletin).

Measures of underlying inflation continued their recent sideways movement after rising from earlier lows. HICP inflation excluding energy and food was 1.0% in February, down from 1.1% in January. It thus continued to hover around the 1% rate that it reached after rising from its low in mid-2016. The decrease in February reflected a decline in services inflation from 1.6% to 1.3%, while non-energy industrial goods inflation remained unchanged at 0.3%. Other measures of underlying inflation, including the Persistent and Common Component of Inflation indicator (PCCI) and the Supercore indicator,[1] which are only available for the period to January, also pointed to a continuation of the broad sideways movement of recent months (see Chart 14). Nonetheless, each of the statistical and model-based measures remained higher than their respective lows in 2016. Looking ahead measures of underlying inflation are expected to increase gradually, driven by a further strengthening of wage growth and the pick-up observed in domestic producer price inflation.

 

Chart 14

Measures of underlying inflation

(annual percentage changes)

Sources: Eurostat and ECB calculations.
Notes: The latest observations are for February 2019 (flash estimate) for HICP excluding energy and food and for January 2019 for all the other measures. The range of measures of underlying inflation consists of the following: HICP excluding energy; HICP excluding energy and unprocessed food; HICP excluding energy and food; HICP excluding energy, food, travel-related items and clothing; the 10% trimmed mean; the 30% trimmed mean; and the weighted median of the HICP. Growth rates for HICP excluding energy and food for 2015 are distorted upwards owing to a methodological change (see Box 5 in this issue of the ECB’s Economic Bulletin).

Price pressures for non-energy industrial goods increased at the later stages of the pricing chain, while signals at the earlier stages were mixed. At the very early stages, pipeline price pressures have rebounded, as the annual rate of change in oil prices and industrial raw material prices (in euro terms) increased markedly in February. Global non-energy producer price inflation, in contrast, declined slightly further in January. The previous weak price pressures in the early stages have had an impact on import price and producer price inflation for intermediate goods, with both continuing to decline since August last year. At the later stages, the year-on-year growth of import prices for non-food consumer goods increased to 1.3% in January from (a revised downwards) 0.4% in December. Also, domestic producer price inflation for these goods increased to 1.0% in January 2019, after recording a stable 0.8% growth in year-on-year terms in the previous three months, and remained above its long-term average (see Chart 15). Overall, pressures on consumer goods prices remained broadly steady in the later stages of the pricing chain, with some weakness in the early stages possibly yet to filter through.

 

Chart 15

Producer and import prices

(annual percentage changes; percentage point contributions)

Sources: Eurostat and ECB calculations.
Notes: The latest observations are for February 2019 for NEER-38, January 2019 for domestic PPI, import prices, and global PPI. “NEER-38” is the nominal effective exchange rate of the euro against the currencies of 38 of the euro area’s most important trading partners. “PPI” measures the monthly development of ex-factory selling prices.

Recent developments in wage growth signal a continued upward trend and support the notion of a gradual build-up in domestic cost pressures. Annual growth in compensation per employee increased to 2.5% in the third quarter of 2018, compared with 2.2% in the second quarter of 2018. Negotiated wage growth was 2.2% in the fourth quarter of 2018, up from 2.1% in the third quarter (see Chart 16). More generally, wage growth indicators now stand visibly higher than in the first half of 2016. These developments are in line with increasing tightness in the labour market. While the early phase of the strengthening of the growth in compensation per employee was driven mainly by wage drift, most of the momentum in recent quarters came from the rise in the annual growth of negotiated wages, which bolstered confidence in the positive outlook for wage growth.

 

Chart 16

Contributions of components of compensation per employee

(annual percentage changes; percentage point contributions)

Sources: Eurostat and ECB calculations.
Note: The latest observations are for the third quarter of 2018 for compensation per employee and the fourth quarter of 2018 for negotiated wage growth.

Market and survey-based measures of longer-term inflation expectations have fallen somewhat. The five-year inflation-linked swap rate five years ahead stood at 1.51% on 6 March 2019, 13 basis points lower than the level which prevailed in mid-December (see Chart 17). The forward profile of market-based measures of inflation expectations continues to point towards a prolonged period of low inflation with a gradual return to inflation levels below, but close to, 2%. The risk-neutral probability of negative average inflation over the next five years implied by inflation options markets is negligible, which suggests that markets currently consider the risk of deflation to be very low. According to the ECB Survey of Professional Forecasters for the first quarter of 2019, longer-term inflation expectations were 1.8%, slightly down from 1.9% compared with the previous survey.

 

Chart 17

Market-based measures of inflation expectations

(annual percentage changes)

Sources: Thomson Reuters and ECB calculations.
Note: The latest observations are for 6 March 2019.

The March 2019 ECB staff macroeconomic projections expect underlying inflation to increase gradually over the projection horizon. On the basis of the information available at mid-February, these projections expect headline HICP inflation to average 1.2% in 2019, 1.5% in 2020 and 1.6% in 2021, compared with 1.6%, 1.7% and 1.8% respectively in the December 2018 Eurosystem staff macroeconomic projections (see Chart 18). This pattern reflects a sharp decline in HICP energy inflation in 2019, which is mainly accounted for by the strong drop in oil prices at the end of 2018 and downward base effects related to their prior increase in 2018. Looking ahead HICP energy prices are expected to grow at subdued rates consistent with the relatively flat oil price futures curve. HICP inflation excluding energy and food will be on a gradual upward path supported by the more gradual but continued economic recovery and the tightening labour market conditions, leading to higher domestic cost pressures. HICP inflation excluding energy and food is expected to rise from 1.2% in 2019 to 1.4% in 2020 and 1.6% in 2021, representing a downward revision of 0.2 percentage point in each year of the projection horizon.

 

Chart 18

Euro area HICP inflation (including projections)

(annual percentage changes)

Sources: Eurostat and the article entitled “March 2019 ECB staff macroeconomic projections for the euro area”, published on the ECB’s website on 7 March 2019.
Notes: The latest observations are for the fourth quarter of 2018 (actual data) and the fourth quarter of 2021 (projection). The ranges shown around the central projections are based on the differences between actual outcomes and previous projections carried out over a number of years. The width of the ranges is twice the average absolute value of these differences. The method used for calculating the ranges, involving a correction for exceptional events, is documented in the “New procedure for constructing Eurosystem and ECB staff projection ranges”, ECB, December 2009. The cut-off date for data included in the projections was 21 February 2019 and thus before the revision to historical data in the HICP on account of methodological changes.

Money and credit

Money growth and credit dynamics moderated in January 2019. Broad money growth has shown strong resilience in the face of the phasing-out of monthly net purchases under the asset purchase programme (APP). At the same time, bank funding and lending conditions remained favourable. Net issuance of debt securities by NFCs declined significantly in the fourth quarter of 2018, against the background of a continuing gradual deterioration in bond market conditions that started in late 2017.

Broad money growth moderated in January, with rates continuing to hover around the level observed since March 2018. The annual growth rate of M3 decreased to 3.8% in January 2019 from 4.1% in December 2018 (see Chart 19). This development shows the resilience of M3 growth in the face of the declining mechanical contribution of APP purchases. M3 growth has eased since late 2017, coinciding with the phasing-out of net asset purchases. This in turn implies that the APP had a smaller positive impact on M3 growth. The narrow money aggregate M1, which includes the most liquid components of M3, continued to make a large contribution to broad money growth, despite declining to 6.2% in January. Money growth continued to receive support from sustained economic expansion and the low opportunity cost of holding the most liquid instruments in an environment of very low interest rates.

 

Chart 19

M3, M1 and loans to the private sector

(annual percentage changes; adjusted for seasonal and calendar effects)

Source: ECB.
Notes: Loans are adjusted for loan sales, securitisation and notional cash pooling. The latest observation is for January 2019.

Overnight deposits remained the main contributor to M3 growth. The annual growth rate of overnight deposits decreased to 6.4% in January, reflecting the moderation in the annual growth of overnight deposits held by NFCs, while the expansion of overnight deposits held by households remained stable. Moreover, steady growth in currency in circulation speaks against any large-scale substitution of cash for deposits in an environment of very low or negative interest rates for the euro area as a whole. Short-term deposits other than overnight deposits (i.e. M2 minus M1) continued to make a negative contribution to M3 growth, although the spread between the interest rates on short-term time deposits and overnight deposits has stabilised since late 2017. Marketable instruments (i.e. M3 minus M2), which are currently growing at a slow pace given the low remuneration of these instruments, had a neutral overall impact on M3 growth.

Credit to the private sector remained the largest driver of broad money growth from a counterpart perspective (see Chart 20). In the context of the aforementioned phasing-out of monthly net purchases under the APP, the positive contribution to M3 growth from general government securities held by the Eurosystem decreased further (see the red parts of the bars in Chart 20). This has been largely offset by a moderate increase in the contribution from credit to the private sector since late 2017 (see the blue parts of the bars in Chart 20). While private credit remained the main source of money creation, the decline in the contribution of the APP has recently been replaced by external monetary flows (see the yellow parts of the bars in Chart 20) and credit to the general government (see the light green parts of the bars in Chart 20). The increasing contribution from net external assets in part reflects investors’ preferences for euro area assets in the context of a greater aversion to risk linked to higher uncertainty. Moreover, purchases of government securities by commercial banks have increasingly stabilised M3 in recent months. These developments mark an ongoing shift towards more self-sustained sources of money creation.

 

Chart 20

M3 and its counterparts

(annual percentage changes; contributions in percentage points; adjusted for seasonal and calendar effects)

Source: ECB.
Notes: Credit to the private sector includes MFI loans to the private sector and MFI holdings of debt securities issued by the euro area private non-MFI sector. As such, it also covers purchases by the Eurosystem of non-MFI debt securities under the corporate sector purchase programme. The latest observation is for January 2019.

Credit dynamics moderated in January. The annual growth rate of MFI loans to the private sector (adjusted for loan sales, securitisation and notional cash pooling) declined to 3.0% in January from 3.4% in December (see Chart 19). This was owing to a strong decline in the annual growth rate of loans to NFCs to 3.3% in January from 3.9% in December. Loan growth for firms, which was accompanied by considerable heterogeneity across countries, matches historical patterns and can be explained by the slowdown in real GDP since early 2018 (see Chart 21). At the same time, the annual growth rate of loans to households remained stable at 3.2% in January, also in a context of pronounced cross-country heterogeneity (see Chart 22). Lending to the private sector continued to be supported by favourable financing conditions, robust growth in business investment, improvements in labour markets, mature housing markets and growth in both residential investment and private consumption. In addition, banks have made progress in consolidating their balance sheets, improving profitability and reducing non-performing loans, although the level of such loans has remained high in some countries.

 

Chart 21

MFI loans to NFCs in selected euro area countries

(annual percentage changes)

Source: ECB.
Notes: Loans are adjusted for loan sales, securitisation and notional cash pooling. The cross-country dispersion is calculated on the basis of minimum and maximum values using a fixed sample of 12 euro area countries. The latest observation is for January 2019.

 

Chart 22

MFI loans to households in selected euro area countries

(annual percentage changes)

Source: ECB.
Notes: Loans are adjusted for loan sales and securitisation. The cross-country dispersion is calculated on the basis of minimum and maximum values using a fixed sample of 12 euro area countries. The latest observation is for January 2019.

Bank funding conditions remained favourable by historical standards. In January, the composite cost of debt financing for euro area banks remained stable, after having progressively increased since the beginning of 2018 (see Chart 23). This development reflected unchanged bank bond yields in the euro area as a whole. Heterogeneity across countries was considerable, given that political uncertainty was high and banks’ access to wholesale funding was uneven. At the same time, the costs of deposit funding remained unchanged. The repercussions of higher costs of funding through the issuance of debt securities on the overall composite cost of funding for banks have been rather limited owing to this type of funding’s limited importance in banks’ funding structures. Overall, therefore, bank funding conditions have remained favourable, reflecting the ECB’s accommodative monetary policy stance and the strengthening of banks’ balance sheets. Moreover, the new series of TLTROs will help to ensure that bank lending conditions remain favourable going forward.

 

Chart 23

Banks’ composite cost of debt financing

(composite cost of deposit and unsecured market-based debt financing; percentages per annum)

Sources: ECB, Markit iBoxx and ECB calculations.
Notes: The composite cost of deposits is calculated as an average of new business rates on overnight deposits, deposits with an agreed maturity and deposits redeemable at notice, weighted by their corresponding outstanding amounts. The latest observation is for January 2019.

Bank lending rates for NFCs and households remained close to their historical lows. In January 2019, the composite bank lending rate for NFCs (see Chart 24) remained broadly stable at 1.63%, close to the historical low of 1.62% seen in May 2018. The composite bank lending rate for housing loans remained broadly stable in January at 1.82%, also close to its historical low in December 2016 (see Chart 25). Composite bank lending rates for loans to NFCs and households have fallen significantly and by more than market reference rates since the ECB’s credit easing measures were announced in June 2014, while heterogeneity across countries remained considerable. Between May 2014 and January 2019 composite lending rates on loans to NFCs and households fell by around 130 and 110 basis points, respectively. The reduction in bank lending rates for loans to NFCs, as well as for loans to small firms (assuming that very small loans of up to €0.25 million are primarily granted to small firms), was particularly significant in those euro area countries that were most exposed to the financial crisis. This indicates a more uniform transmission of monetary policy to bank lending rates across euro area countries and firm sizes.

 

Chart 24

Composite lending rates for NFCs

(percentages per annum; three-month moving averages)

Source: ECB.
Notes: The indicator for the total cost of bank borrowing is calculated by aggregating short and long-term rates using a 24-month moving average of new business volumes. The cross-country standard deviation is calculated using a fixed sample of 12 euro area countries. The latest observation is for January 2019.

 

Chart 25

Composite lending rates for house purchase

(percentages per annum; three-month moving averages)

Source: ECB.
Notes: The indicator for the total cost of bank borrowing is calculated by aggregating short and long-term rates using a 24-month moving average of new business volumes. The cross-country standard deviation is calculated using a fixed sample of 12 euro area countries. The latest observation is for January 2019.

The annual flow of total external financing to euro area NFCs is estimated to have stabilised in the fourth quarter of 2018. Bank lending growth was solid, supported by still-favourable credit standards and a further decline in the relative cost of bank lending. By contrast, net issuance of securities was negative over the quarter, reflecting the moderation of economic growth, lower values of mergers and acquisitions as well as increases in the cost of market-based financing and uncertainty, along with other factors. These developments are, however, becoming increasingly heterogeneous across countries.

In the fourth quarter of 2018 the net issuance of debt securities by NFCs was significantly negative amidst a continuing increase in the cost of debt issuance during that time. The weakness in net issuance activity in the last quarter of 2018 can be partly attributed to the seasonal pattern of the series, but from a more medium-term perspective the annual net issuance flows for December 2018 reached the lowest reading since May 2016 (see Chart 26), and remain in line with the declining trend that started at the beginning of 2017. Market data suggest that the net issuance of debt securities by investment-grade issuers increased in the first months of 2019, while it remained virtually zero in the high-yield segment. The net issuance of listed shares was basically zero in the fourth quarter of 2018.

 

Chart 26

Net issuance of debt securities and quoted shares by euro area NFCs

(annual flows in EUR billions)

Source: ECB.
Notes: Monthly figures based on a 12-month rolling period. The latest observation is for December 2018.

In December 2018, the cost of financing for NFCs edged up further. In December the overall nominal cost of external financing for NFCs, comprising bank lending, debt issuance in the market and equity finance, stood at 4.8%, up from 4.7% in November. The current cost of external financing surpasses the historical low of August 2016 by 57 basis points but remains substantially lower than the level seen in mid-2014, when market expectations regarding the introduction of the public sector purchase programme began to emerge.

Fiscal developments

A mildly expansionary euro area fiscal stance and the operation of automatic stabilisers are providing support to economic activity. At the same time, countries where government debt is high need to continue rebuilding fiscal buffers. All countries should continue to increase efforts to achieve a more growth-friendly composition of public finances. Likewise, the transparent and consistent implementation of the European Union’s fiscal and economic governance framework over time and across countries remains essential to bolster the resilience of the euro area economy.

Following an improvement last year, the euro area general government budget deficit is projected to deteriorate in 2019 and remain broadly stable in the following two years. [2] Based on data for 2018 that are still incomplete, the general government deficit ratio for the euro area is estimated to have stood at 0.5% of GDP, compared with 1.0% of GDP in 2017. The fall in 2018 was mainly the result of favourable cyclical conditions and declining interest payments. The improvement is likely to be reversed this year on account of a significantly lower cyclically adjusted primary balance. The higher deficit is also expected to persist over the next two years (see Chart 27).

The outlook for the euro area general government deficit for the next two years has deteriorated compared with the December 2018 Eurosystem staff macroeconomic projections. The higher deficit is partly the outcome of a lower primary balance reflecting policies that are more expansionary than previously expected in several of the largest euro area countries. It is also the result of a lower cyclical component given that the macroeconomic outlook has been revised downwards.

 

Chart 27

Budget balance and its components

(percentage of GDP)

Sources: ECB and March 2019 ECB staff macroeconomic projections.
Notes: The data refer to the aggregate general government sector of the euro area.

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. [3] This profile is mainly driven by cuts to direct taxes and social security contributions in both Germany and France but it is also a result of relatively dynamic expenditure growth in several countries.

The decline in the euro area aggregate public debt-to-GDP ratio is projected to continue at a slower pace. According to the March 2019 ECB staff macroeconomic projections, the aggregate general government debt-to-GDP ratio in the euro area is expected to decline from 86.8% of GDP in 2017[4] to 81.1% of GDP in 2021. The projected reduction in government debt is supported by both the negative interest rate-growth rate differential[5] and continued primary surpluses (see Chart 28), although deficit-debt adjustments are expected to offset some of these effects. Over the projection horizon, the debt ratio is projected to fall or increase only slowly in all euro area countries but will continue to far exceed the reference value of 60% of GDP in a number of countries. Compared with the December 2018 projections, the decline in the aggregate euro area debt-to-GDP ratio is expected to be more subdued over the whole horizon. This is mainly due to the increasing interest-growth differential in 2019 reflecting the downward revision of GDP growth, as well as lower primary balances.

 

Chart 28

Drivers of change in public debt

(percentage points of GDP)

Sources: ECB and March 2019 ECB staff macroeconomic projections.
Notes: The data refer to the aggregate general government sector of the euro area.

Countries need to continue their fiscal policies in full compliance with the Stability and Growth Pact. This may include allowing automatic stabilisers to operate where appropriate. At the same time, countries where government debt is high need to continue rebuilding fiscal buffers. All countries should continue to increase efforts to achieve a more growth-friendly composition of public finances.

Boxes

Characterising the current expansion across non-euro area advanced economies: where do we go from here?

Prepared by Alina Bobasu, Mariarosaria Comunale, Ramon Gomez-Salvador and Lucia Quaglietti

This box looks at the current phase of the business cycle in major non-euro area advanced economies with a view to assessing the factors behind the transition to weaker growth. [6] Although growth in non-euro area advanced economies has been slowing, signals of a severe slowdown or recession appear contained at the current juncture and our baseline scenario remains one of a modest economic deceleration.

More

Liquidity conditions and monetary policy operations in the period from 31 October 2018 to 29 January 2019

Prepared by Toshi Nakamura and Pamina Karl

This box describes the ECB’s monetary policy operations during the seventh and eighth reserve maintenance periods of 2018, which ran from 31 October 2018 to 18 December 2018 and from 19 December 2018 to 29 January 2019 respectively. Throughout this period the interest rates on the main refinancing operations (MROs), the marginal lending facility and the deposit facility remained unchanged at 0.00%, 0.25% and −0.40% respectively. In parallel, the Eurosystem continued to purchase public sector securities, covered bonds, asset-backed securities and corporate sector securities as part of its asset purchase programme (APP), with a target of €15 billion of net purchases on average per month until the end of December 2018. It then entered the reinvestment phase on 1 January 2019.

More

Employment growth and GDP in the euro area

Prepared by Vasco Botelho and António Dias da Silva

This box analyses developments in the euro area labour market with respect to recent changes in GDP growth. The labour market remained relatively robust throughout 2018, in spite of the slowdown in real GDP growth. A decomposition of GDP into labour productivity, labour market outcomes and demographic trends shows a larger contribution to real GDP growth from employment (see Chart A). In the first three quarters of 2018, economic growth was strongly supported by employment growth and by the stable decline in the unemployment rate. These developments contrast sharply with trends during the early period of the recovery and highlight the strength of the labour market in the euro area against the background of the slowdown in GDP growth in 2018. Indeed, despite the considerable heterogeneity observed across different euro area countries, the aggregate euro area unemployment rate was, in December 2018, at its lowest since October 2008, with the employment-to-population ratio higher than in 2008[7].

More

New features in the Harmonised Index of Consumer Prices: analytical groups, scanner data and web-scraping

Prepared by Martin Eiglsperger

Harmonised indices of consumer prices (HICPs) for food, industrial goods, services and energy are measures that the ECB uses for its more detailed analysis of inflation in the euro area. With the release of the HICPs for January 2019, these analytical groups ‑ special aggregates ‑ are based on a more exact allocation of products. As a result, the distinction between goods and services and between unprocessed and processed food is now more precise. This improvement has been achieved by deriving special aggregates from the HICP’s generic classification – the “European Classification of Individual Consumption according to Purpose” (ECOICOP) – which provides a more detailed level of breakdown than the product classification used thus far. Another recent enhancement is the extended use of supermarket scanner data. “Web-scraping” – an automated approach to collecting mass data from websites – is also being more broadly applied. Overall, these changes reflect better the actual consumer price developments in the economy, especially since they increase the coverage of sales prices.

More

A new method for the package holiday price index in Germany and its impact on HICP inflation rates

Prepared by Martin Eiglsperger

Harmonised indices of consumer prices (HICPs) are regularly updated for changes in consumption weights and the items included, and on occasion also for methodological improvements. One such improvement is a change in the way the price index for package holidays is calculated in the HICP for Germany, which was implemented with the HICP release for January 2019. This has led to revisions of annual rates of change not only for Germany, but also for the euro area as a whole.

More

Interest rate-growth differential and government debt dynamics

Prepared by Cristina Checherita-Westphal

The difference between the average interest rate that governments pay on their debt and the nominal growth rate of the economy is a key variable for debt dynamics and sovereign sustainability analysis. The change in government debt between two years equals the interest paid on the stock of debt, the primary deficit (excess of expenditure, excluding interest payments, over revenue), and other factors (deficit-debt adjustments). For ratios to GDP, the change in debt is then mainly determined by the primary balance and the difference between the interest rate and the GDP growth rate. If the interest rate-growth differential ( ) is strictly positive, a primary fiscal surplus is needed to stabilise or reduce the debt-to-GDP ratio. The higher the initial debt level, the higher the primary surplus will need to be. Conversely, a persistently negative  on government debt   would imply that debt ratios could be reduced even in the presence of primary budget deficits (lower than the debt effect induced by the differential).[8]

More

The European Commission’s 2019 assessment of macroeconomic imbalances and progress on reforms

Prepared by Nick Ligthart

On 27 February 2019, the European Commission published its annual assessment of macroeconomic imbalances and the progress made with structural reforms based on the country-specific recommendations (CSRs) as adopted in July 2018. This assessment is a key part of the European Semester framework for coordinating economic and fiscal policies across the EU. Within this context, the macroeconomic imbalance procedure (MIP) provides a framework for assessing macroeconomic imbalances. It aims to prevent the emergence of harmful imbalances and to actively correct imbalances where they have already become excessive.[9]

More

Article

Taking stock of the Eurosystem’s asset purchase programme after the end of net asset purchases

Prepared by Felix Hammermann, Kieran Leonard, Stefano Nardelli and Julian von Landesberger

Following the Governing Council’s decision in December 2018 to end net asset purchases under the Eurosystem’s asset purchase programme (APP), this article reviews the implementation and effects of the asset purchases. The APP has proved to be an adaptable and effective instrument to ease monetary and financial conditions, foster economic recovery, counteract disinflationary pressures and anchor inflation expectations, thereby supporting a sustained adjustment in the path of inflation towards price stability. The APP has been part of a package of policy measures together with negative interest rates on the deposit facility, forward guidance and targeted longer-term refinancing operations (TLTROs), jointly creating synergies that have enhanced the effectiveness of each of the package’s individual components. From an implementation viewpoint, the Eurosystem ensured that asset purchases were conducted smoothly and flexibly by striving for market neutrality and mitigating unintended side effects for market functioning.

Whereas net asset purchases have come to an end, principal payments from maturing securities purchased under the APP will continue to be reinvested as this, together with enhanced forward guidance, provides the monetary accommodation that the Governing Council judges to be required for the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

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ISSN 2363-3417 (html)

ISSN 2363-3417 (pdf)

DOI 10.2866/662337 (html)

EU catalogue No QB-BP-19-002-EN-Q (html)

EU catalogue No QB-BP-19-002-EN-N (pdf)

  1. For more information on these measures of underlying inflation, see Boxes 2 and 3 in the article "Measures of underlying inflation for the euro area", Economic Bulletin, Issue 4, ECB, 2018.
  2. See the “March 2019 ECB staff macroeconomic projections for the euro area”, published on the ECB’s website on 7 March 2019.
  3. The fiscal stance reflects the direction and size of the stimulus from fiscal policies to the economy, beyond the automatic reaction of public finances to the business cycle. It is measured here as the change in the cyclically adjusted primary balance ratio net of government support to the financial sector. For more details on the concept of the euro area fiscal stance, see the article entitled “The euro area fiscal stance”, Economic Bulletin, Issue 4, ECB, 2016.
  4. As the projections usually take the most recent data revisions into account, there might be discrepancies compared with the latest validated Eurostat data.
  5. For more information, see the box entitled “Interest rate-growth differential and government debt dynamics” in this issue of the Economic Bulletin.
  6. The analysis is based on the following non-euro area countries: United States (US), Japan (JP), United Kingdom (UK), Canada (CA), Switzerland (CH), Sweden (SE), Denmark (DK), Norway (NO) and Australia (AU).
  7. Heterogeneity in unemployment rates remains high, as more than 15 percentage points separate the highest and lowest rates of euro area countries. The employment-to-population ratio, defined here as total employment divided by the segment of the population aged 15-74, increased by 0.8 percentage point, from 58.7% to 59.5%, between the third quarter of 2008 and the third quarter of 2018.
  8.   Equation 1 (the typical debt accumulation equation) provides a simple accounting framework to decompose the change in the government gross debt-to-GDP ratio ( ) into its key drivers, consisting of: (i) the “snowball effect”, i.e. the impact of the difference between the average nominal interest rate charged on government debt ( ) and the nominal GDP growth rate ( ) multiplied by the debt-to-GDP ratio in the previous period ( ); (ii) the primary budget balance (surplus) ratio ( ); and (iii) the deficit-debt adjustment as a share of GDP ( ) or the stock-flow adjustment, comprising factors that affect debt but are not included in the budget balance (such as acquisitions or sales of financial assets).
  9. To identify imbalances, the Commission uses a standardised scoreboard to select countries that require an in-depth review. There are three possible outcomes from these in-depth reviews: “no imbalances”, “imbalances” or “excessive imbalances”. If the Commission identifies imbalances, the country concerned will receive policy recommendations meant to address them. When the imbalances are assessed as being so severe that they are found to be “excessive”, the Commission can take further action by recommending that the Council activates the excessive imbalance procedure (EIP).