Economic and monetary developments

Overview

Based on a thorough assessment of the economic and inflation outlook for the euro area, also taking into account the latest staff macroeconomic projections, the Governing Council took a series of monetary policy decisions at its monetary policy meeting on 6 June to support the convergence of inflation towards levels of below, but c lose to, 2%. Despite the somewhat better than expected data for the first quarter, the most recent information indicates that global headwinds continue to weigh on the euro area outlook. The prolonged presence of uncertainties, related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, is leaving its mark on economic sentiment. At the same time, further employment gains and increasing wages continue to underpin the resilience of the euro area economy and gradually rising inflation. Against this overall background, the Governing Council decided to keep the key ECB interest rates unchanged and adjust its forward guidance on the key ECB rates to indicate its expectation that they will remain at their present levels at least through the first half of 2020, 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. It also reiterated its forward guidance on reinvestments. And, finally, it decided upon the modalities of the new series of quarterly targeted longer-term refinancing operations (TLTRO III), most notably their pricing parameters. The Governing Council also assessed that, at this point in time, the positive contribution of negative interest rates to the accommodative monetary policy stance and to the sustained convergence of inflation is not undermined by possible side effects on bank-based intermediation. However, the Governing Council will continue to monitor carefully the bank-based transmission channel of monetary policy and the case for mitigating measures.

Economic and monetary assessment at the time of the Governing Council meeting of 6 June 2019

Underlying global growth momentum continued to soften in early 2019, notwithstanding better than expected data in some key advanced economies. Survey-based indicators signal continued weakness in global manufacturing activity, despite some recent stabilisation at low levels, and a recent deterioration in activity in the service sector following a period of relative resilience. Global growth is projected to decelerate this year amid high and rising policy and political uncertainty, which is weighing on global investment, and the renewed intensification of trade tensions between the United States and China. While those headwinds are expected to continue to weigh on global activity and trade this year, recent policy measures are expected to provide some support thereafter. 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 economic activity in the medium term. Global inflationary pressures are expected to remain contained, while downside risks to global economic activity have intensified.

Long-term risk-free rates have declined since the Governing Council’s meeting in March 2019 amid market expectations of continued accommodative monetary policy and a resurgence of trade tensions. Non-financial equity prices have increased slightly, exhibiting some volatility, supported by low risk-free rates and improving earnings expectations. However, uncertainty related to resurgent trade tensions is weighing on the prices of risky assets. In foreign exchange markets, the euro has broadly appreciated in trade-weighted terms.

Euro area real GDP growth increased in the first quarter of 2019 to 0.4% quarter on quarter, following the slowdown in the second half of last year against the background of a weaker trend in euro area external demand. However, incoming economic data and survey information point to somewhat weaker growth in the second and third quarters of this year. This reflects the ongoing weakness in international trade in an environment of prolonged global uncertainties, which are weighing, in particular, on the euro area manufacturing sector. At the same time, the euro area services and construction sectors are showing resilience and the labour market is continuing to improve. Looking ahead, the euro area expansion will continue to be supported by favourable financing conditions, the mildly expansionary euro area fiscal stance, further employment gains and rising wages, and the ongoing – albeit somewhat slower – growth in global activity.

This assessment is broadly reflected in the June 2019 Eurosystem staff macroeconomic projections for the euro area. These projections foresee annual real GDP increasing by 1.2% in 2019, 1.4% in 2020 and 1.4% in 2021. Compared with the March 2019 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised up by 0.1 percentage points for 2019 and has been revised down by 0.2 percentage points for 2020 and by 0.1 percentage points for 2021. The risks surrounding the euro area growth outlook remain tilted to the downside on account of the prolonged presence of uncertainties related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.2% in May 2019, after 1.7% in April, reflecting mainly lower energy and services price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months, before rising again towards the end of year. Measures of underlying inflation remain generally muted, but labour cost pressures continue to strengthen and broaden amid high levels of capacity utilisation and tightening labour markets. Looking ahead, underlying inflation is expected to increase over the medium term, supported by the ECB’s monetary policy measures, the ongoing economic expansion and stronger wage growth.

This assessment is also broadly reflected in the June 2019 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.3% in 2019, 1.4% in 2020 and 1.6% in 2021. Compared with the March 2019 ECB staff macroeconomic projections, the outlook for HICP inflation has been revised up by 0.1 percentage points for 2019 and revised down by 0.1 percentage points for 2020. Annual HICP inflation excluding energy and food is expected to be 1.1% in 2019, 1.4% in 2020 and 1.6% in 2021.

The annual growth of broad money and loans to the private sector increased in April 2019. Broad money (M3) growth stood at 4.7% in April 2019, after 4.6% in March. Sustained rates of broad money growth reflect ongoing bank credit creation for the private sector and low opportunity costs of holding M3. Furthermore, M3 growth remained resilient in the face of the fading out of the mechanical contribution of the net purchases under the asset purchase programme (APP). At the same time, lending conditions remained favourable; the annual growth rate of loans to non-financial corporations increased to 3.9% in April 2019 from 3.6% in March. The monetary policy measures decided by the Governing Council, including TLTRO III, will help to safeguard favourable bank lending conditions and will continue to support access to financing, in particular for small and medium-sized enterprises.

The aggregate fiscal stance for the euro area is projected to continue to be mildly expansionary, thereby providing support to economic activity. This profile is mainly driven by cuts in direct taxes and social security contributions in Germany and France, but also by relatively dynamic expenditure growth in several other countries.


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 them to remain at their present levels at least through the first half of 2020, 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, regarding the modalities of the new series of quarterly targeted longer-term refinancing operations (TLTRO III), the Governing Council decided that the interest rate in each operation will be set at a level that is 10 basis points above the average rate applied in the Eurosystem’s main refinancing operations over the life of the respective TLTRO. For banks whose eligible net lending exceeds a benchmark, the rate applied in TLTRO III will be lower, and can be as low as the average interest rate on the deposit facility prevailing over the life of the operation plus 10 basis points.

These decisions were taken to provide the monetary accommodation necessary for inflation to remain on a sustained path towards levels that are below, but close to, 2% over the medium term. In fact, they ensure that financial conditions will remain very favourable, supporting the euro area expansion, the ongoing build-up of domestic price pressures and, thus, headline inflation developments over the medium term. At the same time, looking ahead, the Governing Council is determined to act in the event of adverse contingencies and also stands ready to adjust all of its instruments, as appropriate, to ensure that inflation continues to move towards the Governing Council’s inflation aim in a sustained manner.


External environment

Underlying global growth momentum continued to soften in early 2019, notwithstanding better than expected data in some key advanced economies. This is in line with survey-based indicators, which signal continued weakness in global manufacturing activity. Following a period of relative resilience, activity in the service sector has also deteriorated recently. Global growth is projected to decrease this year amid high and rising policy and political uncertainty, which is weighing on global investment, and the renewed intensification of trade tensions between the United States and China. While those headwinds are expected to continue to weigh on global activity and trade this year, recent policy measures are expected to provide some support thereafter. 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 economic activity in the medium term. Global inflationary pressures are expected to remain contained, while downside risks to global economic activity have intensified.

Global economic activity and trade

Underlying global growth momentum continued to soften in early 2019, notwithstanding better than expected data in some key advanced economies. In the United States, Japan and the United Kingdom, growth was better than expected in the first quarter. However, this mostly reflected temporary factors. In the United States and Japan, economic activity was supported by positive contributions from net trade, which, however, conceal negative growth rates in real imports of goods and services. Inventory building also bolstered growth, while domestic demand was subdued. In the United States, the latter was associated with the partial federal government shutdown. A stronger than expected outturn in the United Kingdom largely reflected strong government spending and significant stock-building by businesses in the run-up to the original deadline of 29 March for the country’s withdrawal from membership of the European Union (Brexit). In China, the economy remained on a path of gradual deceleration, cushioned by expansionary policy measures.

Survey-based indicators confirm a gradual weakening in growth momentum. The global composite output Purchasing Managers’ Index (PMI), excluding the euro area, softened in the first quarter of 2019 and weakened further in April and May. This is mainly related to a weaker performance across advanced economies, while emerging market economies have recorded a slightly smaller deterioration in activity. Global activity in the service sector, which had been more resilient overall in recent months, deteriorated in May, alongside a further decline in global manufacturing activity (see Chart 1).

 

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 May 2019. “Long-term average” refers to the period from January 1999 to May 2019.

Global financial conditions have been volatile in recent months. In advanced economies, they are broadly unchanged from the levels seen at the time of the March 2019 ECB staff macroeconomic projections. This stability, however, masks two distinct developments: financial conditions initially eased in response to monetary policy actions taken in the United States and other key advanced economies, but have tightened since the announcements of new tariffs between the United States and China. The latter development also contributed to a tightening of financial conditions in China and, to a lesser extent, in other emerging market economies. Financial conditions in Turkey have also tightened considerably in recent weeks owing to a renewed sharp depreciation of the lira, against the background of dwindling foreign currency reserves and rising political uncertainty. In global stock markets similar developments have been observed. Until the news about new tariffs broke, global equity prices had been rising. Since then global stock markets have declined amid increased volatility.

Global growth is projected to decelerate this year amid increasing headwinds. These headwinds include weak global manufacturing activity and trade in an environment of high and rising policy and political uncertainty. The sizeable procyclical fiscal stimulus in the United States, including lower taxes and increased expenditure, continues to provide impetus to US growth this year. In China, the slowdown in domestic demand has been cushioned by policy measures, especially those related to fiscal policy. Recent monetary policy actions across key advanced economies have supported the easing of global financial conditions and helped to contain the impact of policy uncertainties. However, the positive effect of these factors on demand seems to have been eroded by the recent escalation of the trade dispute between the United States and China.

Looking further ahead, global growth is projected to stabilise at relatively low levels 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 binding, and policy support may gradually diminish amid positive output gaps and low unemployment rates. Second, China is expected to continue its orderly transition to a more balanced, albeit weaker, growth path that is less dependent on investment and exports. Finally, growth is projected to recover in several key emerging market economies 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 strong, notwithstanding the headwinds related to the trade dispute with China and the less favourable external environment. The strong labour market, accommodative financial conditions and current fiscal stimulus continue to support growth, while the adverse impact of the partial federal government shutdown on domestic demand is assumed to be temporary. Overall, real GDP expanded at an annualised rate of 3.1% in the first quarter of 2019, accelerating from 2.2% in the final quarter of last year. However, the surprisingly strong growth data in the first quarter also reflected temporary factors, such as the positive contributions from inventories and falling imports. At the same time, domestic demand has declined, suggesting subdued underlying growth. Annual headline consumer price inflation picked up to 2.0% in April from 1.9% in the previous month, largely on account of increasing energy prices. Consumer price inflation excluding food and energy also increased slightly, rising to 2.1% in April. Growth is projected to gradually return to the potential growth rate of just below 2%, while consumer price inflation is expected to remain slightly above 2% over the medium term.

Growth in China has recorded a gradual slowdown. In the first quarter of 2019 annual GDP growth stabilised, supported by a positive net trade contribution as imports decreased more than exports. Looking through their volatility, the latest indicators point to stable growth momentum in the near term. A number of fiscal and monetary policy measures announced and implemented by the Chinese authorities recently are expected to cushion domestic demand and thus to deliver a smooth deceleration in activity this year. The recent escalation of the trade dispute with the United States is expected to weigh on trade, while its impact on growth is expected to be contained by policies. 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.

In Japan, underlying growth momentum remains muted. Growth in the first quarter of 2019 was 0.5% (quarter on quarter), which was better than expected, as a number of transitory factors were at play, including a large positive contribution from net exports owing to a sharp contraction in imports which exceeded the weakness in exports. Looking ahead, economic activity is expected to resume its path of moderate growth. The strong labour market and still favourable financial conditions remain supportive, although the economy is facing headwinds related to weak foreign demand, especially from China and the rest of Asia. Households are expected to frontload purchases ahead of the consumption tax hike scheduled for October 2019, which could in turn provide a temporary boost to activity over the summer months. In addition, fiscal measures aimed at counterbalancing the negative impact of the higher consumption tax are expected to support demand later in the year. Wage growth is still modest – despite the very tight labour market – and inflation expectations are stable at low levels, suggesting that inflation will remain well below the Bank of Japan’s 2% target over the medium term.

In the United Kingdom, growth rebounded in the first quarter of 2019 on the back of a fiscal boost and strong stock-building. Against the background of a last-minute extension to the long-anticipated departure date of the United Kingdom from the European Union, strong stockpiling, together with fiscal support and better than expected data on both consumption and private investment, resulted in quarterly UK real GDP growth of 0.5% in the first quarter, after a modest 0.2% in the final quarter of 2018. Net trade made a negative contribution to headline growth as imports surged at a rate rarely seen in the past 40 years, partly owing to inventory building, while exports remained flat. However, short-term indicators at the start of the second quarter suggest a continuation of the broad underlying trend of slowing growth momentum seen since the referendum on EU membership. Annual CPI inflation declined to 1.8% in the first quarter of 2019 – slightly below the Bank of England’s 2.0% target – as sharp reductions in energy prices fed through to headline inflation. Stronger domestic cost pressures from higher unit labour costs amid higher wage growth at the start of 2019 have been largely offset by the decline in import prices as the impact of the past depreciation of the pound sterling following the referendum continues to wane. CPI inflation rebounded slightly to 2.1% in April 2019 largely as a consequence of an increase in retail energy prices, as well as marked rises in air fares for the Easter period. Over the medium term growth is expected to remain below the level recorded prior to the referendum.

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 the strong labour market performance. However, the slowdown in the euro area is weighing on the growth outlook for this region. Over the medium term the pace of economic expansion in these countries is expected to decelerate further towards potential.

The outlook for economic activity in large commodity-exporting countries remains mixed. The outlook for growth in Russia is shaped by developments in global oil markets, the execution of fiscal and structural policies, and the international sanctions under which the economy is currently operating. As a result, growth is expected to decelerate somewhat in the medium term. In contrast, growth in Brazil is projected to strengthen, supported by accommodative financial conditions. However, the existing fiscal constraints and uncertainties about the implementation of the current reform agenda continue to weigh on investment.

In Turkey, economic activity contracted significantly in the fourth quarter of 2018. This contraction reflects the legacy of last summer’s financial turmoil, high inflation, and procyclical monetary and fiscal policies. The economy returned to growth in the first quarter of 2019, supported by fiscal spending and higher lending by state-owned banks in the run-up to local elections in March. The expected disappearance of these supportive factors, together with the recent tightening of financial conditions, could undermine the projected gradual recovery in economic activity this year.

Global trade momentum weakened significantly at the turn of the year. It has decelerated considerably more than global activity. This is explained by weaker global investment activity and a turn in the global tech cycle[1] amid high and rising policy and geopolitical uncertainty, which in turn weighed on manufacturing output and trade. The volume of global merchandise imports, excluding the euro area, contracted by 0.6% in March in three-month-on-three-month terms, confirming subdued trade momentum in the first quarter (see Chart 2). As survey indicators signal a further deterioration in global manufacturing activity, the current weakness in global trade is likely to continue in the near term.

Bilateral trade talks between the United States and China suffered a setback in early May. The US Administration announced that it would increase the tariff rate on USD 200 billion of Chinese exports from 10% to 25%. This increase was originally scheduled for 1 January 2019, but had been postponed twice: initially for three months owing to the temporary truce agreed between the two countries in early December, and again in late February amid tangible progress in the bilateral trade talks. China retaliated by raising the tariff rate on USD 60 billion of US exports from between 5% and 10%, to between 10% and 25%. In addition, the risk of a further escalation looms large, as the US Administration has threatened to impose additional 25% tariffs on all remaining US imports from China. The prospect of a further intensification of the trade dispute between the two countries has raised global uncertainty and is weighing on investment. Moreover, the possibility that the US Administration may impose new tariffs on imports from other countries cannot be ruled out. For instance, in mid-May it announced that new tariffs of 25% on imported automobiles and auto parts, focusing primarily on imports from the EU and Japan, would be postponed for up to six months, allowing time for bilateral trade negotiations between the United States and these trading partners.

 

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 -3 -2 -1 0 1 2 3 4 2012 2013 2014 2015 2016 2017 2018 2019 Global merchandise imports excluding the euro area (left-hand scale) Average global merchandise imports excluding the euro area, 1991-2018 (left-hand scale) Global PMI, manufacturing output excluding the euro area (right-hand scale) Global PMI, new export orders excluding the euro area (right-hand scale)

Sources: Markit, CPB Netherlands Bureau for Economic Policy Analysis and ECB calculations.
Note: The latest observations are for May 2019 for the PMIs and March 2019 for global merchandise imports.

Global economic growth is projected to weaken this year, before stabilising over the medium term. According to the June 2019 Eurosystem staff macroeconomic projections, global real GDP growth (excluding the euro area) is projected to decelerate to 3.3% this year, from 3.8% in 2018. This reflects increasing headwinds to global growth in an environment of high and rising political and policy uncertainty. Over the period 2020-21 world economic activity is projected to stabilise at 3.6%, as the (cyclical) slowdown in key advanced economies and China’s transition to a more moderate growth path are expected to be counterbalanced by a recovery in several key emerging market economies. As the growth headwinds weigh more significantly on trade-intensive demand components, such as investment, growth in euro area foreign demand is projected to slow more significantly than global activity this year, falling to 1.7%, from 3.6% in 2018. Global imports are projected to gradually increase and grow in line with global activity over the medium term. Compared with the March 2019 ECB staff macroeconomic projections, global GDP growth has been revised slightly downwards for this year. At the same time, growth in euro area foreign demand has been revised downwards more significantly over the projection horizon. From a geographical perspective, these revisions reflect weaker than expected trade prospects for China and the rest of Asia, as well as the outlook of slower import growth across some key trading partners, including the United Kingdom and other European countries outside the euro area.

Downside risks to global activity have intensified lately. A further escalation of trade disputes may pose a risk to global trade and growth. Moreover, a “no deal” Brexit scenario could have more adverse spillover effects, especially in Europe. A sharper slowdown of China’s economy could be harder to counteract with efficient policy stimulus and might prove a challenge to the ongoing rebalancing process in China. Repricing in financial markets might weigh significantly on vulnerable emerging market economies. A further escalation of geopolitical tensions could also adversely affect global activity and trade.


Global price developments

While oil prices have declined since April, they have recently been volatile. Since April oil prices have declined by 13%. However, they have exhibited more pronounced volatility recently. While potential disruptions to the global oil supply owing to geopolitical tensions, particularly in the Middle East, have sent oil prices higher, concerns over trade tensions between the United States and China and their impact on global demand have lately led to downward pressure on oil prices.

In the June 2019 Eurosystem staff macroeconomic projections oil prices are expected to increase in the near term and to decline over the projection horizon. Amid short-term volatility, supply factors have continued to bolster oil prices, in particular the agreement between OPEC and other major oil producers to curb production. However, weaker global oil demand and higher than expected shale oil production in the United States could also weigh on oil prices. Consequently, the oil price assumptions underpinning the June 2019 Eurosystem staff macroeconomic projections were around 10.4% higher for this year (and 7.3% and 3.4% higher for 2020 and 2021 respectively) relative to the assumptions underpinning the March 2019 ECB staff macroeconomic projections. Since the cut-off date for the June projections, however, the price of oil has declined, with Brent crude oil standing at USD 61 per barrel on 5 June.

Global inflationary pressures remain contained. In countries belonging to the Organisation for Economic Co-operation and Development (OECD), annual headline consumer price inflation averaged 2.5% in April 2019, up from 2.3% in the previous month, owing to an increase in the contribution of the energy component (see Chart 3). Core inflation (excluding food and energy) increased slightly to 2.2% in April from 2.1% in March. Tight labour market conditions across the major advanced economies have so far translated into only moderate wage increases, suggesting that underlying inflation pressures remain subdued. Nevertheless, they should recover gradually over the projection horizon, reflecting diminishing slack.

 

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 components except food and energy Inflation excluding food and energy Inflation including all components

Sources: OECD and ECB calculations.
Note: The latest observations are for April 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 gradually decelerate over the medium term. This reflects the impact of a downward sloping oil price futures curve, which is expected to outweigh the upward pressure arising from gradually diminishing global spare capacity.


Financial developments

Since the Governing Council’s meeting in March 2019, global long-term risk-free rates have declined amid both market expectations of continuing accommodative monetary policy and a resurgence of trade tensions. Non-financial equity prices have increased slightly, amid some volatility, supported by the low risk-free rates and improving earnings expectations. Uncertainty related to trade tensions is weighing on the prices of risky assets. In foreign exchange markets, the euro has appreciated in trade-weighted terms.

In the review period long-term yields in both the euro area and the United States continued their decline which started in late 2018. During the period under review (7 March to 5 June 2019), the euro area ten-year risk-free overnight index swap (OIS) rate fell by 31 basis points to around 0.11% and the GDP-weighted euro area ten-year sovereign bond yield fell by 27 basis points to 0.50% (see Chart 4). Ten-year sovereign bond yields in the United States and United Kingdom also dropped, by 50 and 32 basis points respectively. The fall in global long-term yields comes on the back of communications from both the Federal Reserve System and the ECB that were perceived by market participants as suggesting continuing accommodative monetary policy. It also reflects the resurgence of trade tensions since early May.

 

Chart 4

Ten-year sovereign bond yields

(percentages per annum)