Update on economic and monetary developments

Summary

Incoming information since the last Governing Council meeting in early June indicates that, while further employment gains and increasing wages continue to underpin the resilience of the economy, softening global growth dynamics and weak international trade are still weighing on the euro area outlook. Moreover, the prolonged presence of uncertainties, related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, is dampening economic sentiment, notably in the manufacturing sector. In this environment, inflationary pressures remain muted and indicators of inflation expectations have declined. Therefore, a significant degree of monetary stimulus continues to be necessary to ensure that financial conditions remain very favourable and support the euro area expansion, the ongoing build-up of domestic price pressures and, thus, headline inflation developments over the medium term. Accordingly, the Governing Council adjusted its forward guidance on policy interest rates and underlined its determination to act if the medium-term inflation outlook continues to fall short of its aim.

Survey indicators suggest that global economic activity continued to weaken in the second quarter of 2019 and the drop in the global services output Purchasing Managers' Index in June raises the risk of a more broad-based deterioration in the global growth outlook. Global import growth shifted back into positive territory in April after four months of continued contraction, but heightened trade tensions persist. Global inflation decreased in May, driven largely by a slowdown in energy prices.

Since the Governing Council’s meeting in June 2019, euro area long-term risk-free rates have declined amid market expectations of continuing accommodative monetary policy. Sovereign spreads have remained broadly stable, albeit with a large decrease in Italian spreads. Equity prices have increased, supported by the low risk-free rates, and spreads on corporate bonds have decreased. In foreign exchange markets, the euro has depreciated moderately in trade-weighted terms.

Following an increase of 0.2% in the fourth quarter of 2018, euro area real GDP increased by 0.4%, quarter on quarter, in the first quarter of 2019. Incoming economic data and survey information continue to point to somewhat slower growth in the second and third quarters. This mainly reflects the ongoing weakness in international trade in an environment of prolonged global uncertainties, which are particularly affecting the euro area manufacturing sector. At the same time, activity in the services and construction sectors is resilient and the labour market continues to improve. Looking ahead, the euro area expansion will continue to be supported by favourable financing conditions, further employment gains and rising wages, as well as the mildly expansionary euro area fiscal stance and the ongoing – albeit somewhat slower – growth in global activity.

Euro area annual HICP inflation increased to 1.3% in June 2019, from 1.2% in May, as lower energy price inflation was more than offset by higher HICP inflation excluding food and energy. 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 the year. Looking through the recent volatility due to temporary factors, measures of underlying inflation remain generally muted. Indicators of inflation expectations have declined. While labour cost pressures have strengthened and broadened amid high levels of capacity utilisation and tightening labour markets, the pass-through of cost pressures to inflation is taking longer than previously anticipated. Over the medium term underlying inflation is expected to increase, supported by monetary policy measures, the ongoing economic expansion and stronger wage growth.

Monetary dynamics remained resilient despite the fading-out of the positive impact of monthly net purchases under the asset purchase programme (APP) and weaker euro area economic growth. Credit to the private sector remained the main source of money creation and the contribution of net external assets also remained strong. The growth rate of loans to non-financial corporations (NFCs) remained relatively robust, benefiting from bank lending rates at new historical lows and favourable bank lending conditions, despite some tightening of credit standards on NFC loans in the second quarter of 2019. In May 2019 the net issuance of debt securities by euro area NFCs moderated after four consecutive months of strong issuance activity. Market debt financing costs for NFCs continue to be very favourable.

Against this overall background, the Governing Council decided to keep the key ECB interest rates unchanged and expects them to remain at their present or lower 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 its aim over the medium term.

The Governing Council confirmed that the Eurosystem will continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when the key ECB interest rates are lifted, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

The Governing Council also underlined the need for a highly accommodative stance of monetary policy for a prolonged period of time, as inflation rates, both realised and projected, have been persistently below levels that are in line with its aim. Accordingly, if the medium-term inflation outlook continues to fall short of its aim, the Governing Council is determined to act, in line with its commitment to symmetry in the inflation aim. It therefore stands ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner.

In this context, the Governing Council has tasked the relevant Eurosystem Committees with examining options, including ways to reinforce forward guidance on policy rates, mitigating measures such as the design of a tiered system for reserve remuneration, and options for the size and composition of potential new net asset purchases.


External environment

Survey indicators suggest that global economic activity continued to weaken in the second quarter of 2019. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area was unchanged in June (see Chart 1), as a marginal increase in services output was offset by a decline in manufacturing. In quarterly terms, however, the PMI declined in the second quarter to 51.5, from 52.8 in the previous quarter (on the back of a drop in both the manufacturing and services indices since March), which is consistent with a softening in global economic activity. The manufacturing output PMI has been decreasing steadily over the past year and in June fell below the 50 threshold indicating a contraction in activity. After a period of relative stability, the services index also declined in the second quarter, but continues to indicate an expansion. Developments were mixed across countries in the second quarter. Among advanced economies, the composite output PMI decreased in the United States and the United Kingdom (in the latter falling below the expansionary threshold in June), while it increased slightly in Japan. In emerging market economies, the composite output PMI remained broadly unchanged in China, while it decreased in India, Russia and Brazil. In Brazil, it fell below the expansionary threshold despite a moderate pick-up in June.

 

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 output excluding the euro area

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

The drop in the global services output PMI in the second quarter increases the risk of a more broad-based deterioration in the global growth outlook. Global growth in investment has declined in the last few quarters, mainly as a result of heightened uncertainty and tighter financing conditions (see Box 1). Aggregate private consumption growth has remained more resilient so far, supported by robust labour markets. However, the decline in the second quarter in the services output PMI, which is closely related to consumption, poses downside risks to the latter’s near-term outlook. Some support for global economic growth could come from the recent loosening of global financial conditions, driven primarily by market expectations of monetary easing in large economies. Nonetheless, risks to the global growth outlook remain to the downside as uncertainty – particularly related to trade tensions – persists.

After four months of continued contraction, global import growth shifted back into positive territory in April. According to data from CPB, global merchandise imports (excluding the euro area) grew marginally in April, following four months of continued contraction (see Chart 2). In emerging economies, imports expanded for the first time in six months (by 0.9%, compared with a drop of 1.0% in March), while in advanced economies they shrank by 0.5%. A wider range of high-frequency trade indicators (also covering May) suggest positive but still weak trade growth in the near term. Nonetheless, the new export orders PMI remained below the expansionary threshold in June (see Chart 2).

 

Chart 2

Global trade and export orders

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

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, 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 April 2019 for global merchandise imports and June 2019 for the PMI.

Heightened trade tensions continue. Trade tensions between the United States and China escalated in May, when the United States announced tariff increases on Chinese imports and China retaliated by raising its tariffs on US imports. At the G20 summit in Osaka at the end of June, however, the two countries reached an agreement to restart trade talks. Moreover, President Trump announced a relaxation of the restrictions on US companies selling equipment to Huawei Technologies which were announced by the US Department of Commerce in mid-May. Other trade issues remain unresolved, however. The US administration has delayed taking a decision on possible increases in car tariffs to mid-November 2019, while talks with the EU on a new trade agreement, announced in July 2018, are still ongoing.

Global inflation decreased in May. Annual consumer price inflation in the Organisation for Economic Co-operation and Development (OECD) countries decreased to 2.3% in May, from 2.5% in April, driven largely by a slowdown in energy prices. Excluding food and energy prices, it slowed marginally to 2.1% in May. Tight labour market conditions across major advanced economies, in particular the United States, have so far translated into only moderate wage increases, suggesting that underlying inflation pressures remain subdued.

Oil prices have increased marginally since early June. Tensions in the Middle East due to the stand-off between the United States and Iran, as well as the agreement by key oil producers to extend their supply cuts by nine months, have supported the oil price. Nonetheless, downward revisions of the expected demand for oil have eased market tightness and weighed on the price. Among non-oil commodities, metal prices have increased amid supply constraints in the iron ore market, while food prices have remained broadly unchanged.

Economic expansion in the United States remains solid but the pace of growth is likely to decelerate. US real GDP expanded at an annualised rate of 3.1% in the first quarter of 2019, up from 2.2% in the previous quarter. The acceleration in the first quarter reflected an upturn in government spending, private inventories and net exports, which were partly offset by slower private consumption. While overall GDP growth remains supported by strong fundamentals, notably a robust labour market, economic activity is expected to have decelerated in the second quarter of this year as the effects of the fiscal stimulus in 2018 faded and the positive inventory effect reversed. Inflationary pressures remain muted. Annual headline CPI inflation slowed slightly to 1.6% in June, from 1.8% in May. The decline was driven mainly by a sharp drop in energy prices. Inflation excluding food and energy increased marginally to 2.1%.

Economic activity strengthened in Japan in the first quarter of 2019, despite weaker sentiment. Real GDP increased by 0.6% quarter on quarter in the first quarter of 2019, after 0.5% in the previous quarter. Growth was mainly supported by net exports, as imports fell strongly, while domestic demand remained subdued. High frequency indicators point to a strengthening in domestic activity in the second quarter. Private consumption growth increased in April and May; this partly reflected the impact of the extended Golden Week holidays in early May, while the increase in durable goods purchases could reflect frontloading ahead of the VAT hike scheduled for October. Stronger consumption in turn supported imports, which rebounded in the second quarter from the exceptionally low levels recorded in the first. Consumer price inflation declined slightly in May to 0.7% from 0.9% in April, reflecting primarily the anticipated decline in accommodation service prices owing to a steep fall in demand following this year’s extension of the Golden Week holidays. Inflation excluding food and energy also moderated in year-on-year terms, to 0.3% from 0.5% in April.

In the United Kingdom, real GDP growth accelerated to 0.5% in the first quarter of 2019 from 0.2% at the end of last year, mainly on the back of Brexit-related stock-building. Domestic demand contributed positively, while net trade reduced GDP growth as imports surged. Business investment increased following four quarters of contraction. A strong quarter-on-quarter growth contribution from inventories, as well as the exceptionally high import growth, reflected increased stockpiling against a background of growing fears of a “no-deal” Brexit at the end of March. Overall, economic activity is expected to remain muted in the coming quarters, given high Brexit-related uncertainty and wider concerns related to global economic developments. Annual CPI inflation was 2.0% in June 2019, unchanged from May.

Economic growth in China slowed in the second quarter. Annual real GDP growth declined to 6.2% year-on-year from 6.4% in the first quarter. Final consumption was the main contributor to growth. The decline in its contribution was offset by a rising contribution from capital formation, while the contribution from net exports declined. June data on industrial production, retail sales and fixed-asset investment suggest growth has been picking up, after weaker outcomes in the previous two months. The authorities have indicated they intend to maintain monetary and fiscal support to stabilise growth in line with the official target for 2019 of 6.0%-6.5%. Annual headline CPI inflation was stable in June at 2.7%, while inflation excluding food and energy remained at 1.6%.


Financial developments

Long-term sovereign yields have declined in the euro area, continuing the downward trend that started in late 2018. During the period under review (from 6 June to 24 July 2019) the GDP-weighted euro area ten-year sovereign bond yield declined by 29 basis points to 0.19% amid market expectations of continuing accommodative monetary policy (see Chart 3). Ten-year sovereign bond yields in the United States and United Kingdom also decreased over the review period, to around 2.05% and 0.68% respectively.

 

Chart 3

Ten-year sovereign bond yields

(percentages per annum)