Update on economic and monetary developments

Summary

Incoming information since the last Governing Council meeting in early September confirms the previous assessment of a protracted weakness in euro area growth dynamics, the persistence of prominent downside risks and muted inflation pressures. The risks surrounding the euro area growth outlook remain on the downside. In particular, these risks pertain to the prolonged presence of uncertainties, related to geopolitical factors, rising protectionism and vulnerabilities in emerging markets. At the same time, ongoing employment growth and increasing wages continue to underpin the resilience of the euro area economy. Against this overall background, the Governing Council at its October meeting kept its monetary policy stance unchanged, confirming the decisions taken at the previous meeting in September. The comprehensive package of policy measures that was decided at the September meeting provides substantial monetary stimulus, and thus will contribute to a further easing in borrowing conditions for firms and households. This will support the euro area expansion, the ongoing build-up of domestic price pressures and, thus, the sustained convergence of inflation to the Governing Council’s medium-term inflation aim.

Survey indicators suggest subdued, but stabilising, global economic activity in the third quarter of 2019. Following a protracted period of weakness, the global manufacturing Purchasing Managers’ Index (PMI) has improved over recent months and returned to expansionary territory. The global services PMI remained expansionary in the third quarter. Global trade (excluding the euro area) contracted in the first half of 2019 owing to weak intra-Asian trade, but short-term indicators of global trade signal low, but positive, growth in the third quarter. Global inflation declined to below 2% in August, driven in part by lower energy price inflation, while inflation excluding food and energy remained stable at 2.3%.

Since the Governing Council meeting in September 2019, euro area long-term risk-free rates have increased and the EONIA forward curve has shifted upwards, largely reflecting lower market expectations of another cut in the deposit facility rate before the end of the year. Sovereign spreads have remained broadly stable, with some countries seeing a slight increase during the review period. Equity prices have increased, despite higher discount rates, owing to a falling equity risk premium. In foreign exchange markets, the euro has broadly strengthened in trade-weighted terms.

Euro area real GDP growth was confirmed at 0.2%, quarter on quarter, in the second quarter of 2019, following a rise of 0.4% in the previous quarter. Incoming economic data and survey information continue to point to moderate but positive growth in the euro area in the second half of this year. This slowdown in growth mainly reflects the ongoing weakness of international trade in an environment of persistent global uncertainties, which continue to weigh on the euro area manufacturing sector and are dampening investment growth. At the same time, the services and construction sectors remain resilient, despite some moderation. The euro area expansion is supported by favourable financing conditions, further employment gains in conjunction with rising wages, the mildly expansionary euro area fiscal stance and the ongoing – albeit somewhat slower – growth in global activity.

Euro area annual HICP inflation decreased from 1.0% in August 2019 to 0.8% in September, reflecting lower food and energy price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline slightly further before rising again at the end of the year. Measures of underlying inflation remained generally muted and indicators of inflation expectations stand at low levels. While labour cost pressures have strengthened amid tighter labour markets, the weaker growth momentum is delaying their pass-through to inflation. Over the medium term inflation is expected to increase, supported by the ECB’s monetary policy measures, the ongoing economic expansion and robust wage growth.

Regarding monetary developments, broad money (M3) growth increased to 5.7% in August 2019, after 5.1% in July. M3 growth continues to be backed by bank credit creation, and the narrow monetary aggregate M1 remained the main contributor to broad money growth. Furthermore, the annual growth of broad money and loans to the private sector remained robust as the mechanical contribution of net purchases under the asset purchase programme (APP) faded out and economic momentum weakened. The annual growth rate of loans to non-financial corporations increased to 4.3% in August, from 4.0% in July, while the annual growth rate of loans to households remained unchanged at 3.4%. At the same time, favourable bank funding and lending conditions continued to support loan flows and thereby economic growth. The ECB’s accommodative monetary policy stance will help to safeguard favourable bank lending conditions and will continue to support access to financing, in particular for small and medium-sized enterprises.

Combining the outcome of the economic analysis with the signals coming from the monetary analysis, the Governing Council confirmed that an ample degree of monetary accommodation is still necessary for the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

On the basis of this assessment, the Governing Council decided to keep the key ECB interest rates unchanged and expects them to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.

The Governing Council confirmed that it will restart net purchases under the ECB’s APP at a monthly pace of €20 billion as from 1 November. It expects them to run for as long as necessary to reinforce the accommodative impact of the ECB’s policy rates, and to end shortly before the Governing Council starts raising the key ECB interest rates.

The Governing Council also intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP 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.

The Governing Council reiterated the need for a highly accommodative stance of monetary policy for a prolonged period of time to support underlying inflation pressures and headline inflation developments over the medium term. In particular, the Governing Council’s forward guidance will ensure that financial conditions adjust in accordance with changes to the inflation outlook. In any case, the Governing Council continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry.


External environment

Global survey indicators of economic growth suggest subdued, but stabilising, economic activity. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area remained in expansionary territory in the third quarter of 2019 and was broadly unchanged compared with the second quarter. Both the manufacturing components and the services components remained stable. Following a protracted period of weakness, the global manufacturing PMI has improved over recent months and returned to expansionary territory, while the global services PMI remained expansionary in the third quarter. Developments were mixed across and within regions. In the third quarter of 2019 the composite output PMI increased in the United States, but decreased in Japan and fell below the expansionary threshold in the United Kingdom. In emerging market economies, the composite output PMI increased in Brazil and India – despite India’s index experiencing a sharp decline to below the neutral threshold in September – and decreased marginally in China and Russia (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 Advanced economies excluding the euro area Emerging market economies

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

Risks to the global economy remain to the downside amid a further escalation of trade disputes, high uncertainty related to Brexit and a potentially slower recovery in a number of emerging market economies. A continual escalation of trade disputes would likely imply higher adjustment costs in the transition to a new trading regime and possible further disruptions to global supply chains over time. This could, in turn, amplify the impact on economic activity of already-enacted tariffs. Risks related to Brexit remain high. The recovery in a number of emerging market economies that have experienced sharp recessions may be less vigorous than expected. The speed of recovery depends on the extent to which domestic policies address structural impediments to investment and potential growth. A slower recovery in these economies would ultimately translate into more sluggish global growth.

Global financial conditions have remained broadly stable in both advanced and emerging market economies. In September risk sentiment had improved somewhat against the backdrop of renewed expectations of a trade deal between the United States and China, subsiding risks of a disorderly Brexit and strong economic data in the United States. However, risk appetite has since faded again and global equity prices have reversed some of their previous gains. While the Federal Open Market Committee cut interest rates further at its September meeting, weaker than expected economic data has led financial markets to price in further monetary accommodation.

Global trade momentum is expected to remain muted, as higher tariffs are set to come fully into effect at the end of the year. Global trade (excluding the euro area) contracted in the first half of 2019 owing to weak intra-Asia trade, reflecting a slowing down of the Chinese economy and of technology-related trade. Developments in the first half of the year were also influenced by the high volatility in UK imports linked to Brexit-related stockpiling efforts. Short-term indicators of global trade signal low, but positive, growth. Global merchandise imports continued to expand in August in monthly terms, pointing to positive world trade growth in the third quarter. The global PMI for new export orders, while remaining below the neutral threshold, edged up slightly in September following five consecutive months of decline (Chart 2).

 

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 August 2019 for global merchandise imports and September 2019 for the PMIs.

Global inflation remains subdued, in spite of tight labour market conditions in major advanced economies. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) declined to below 2% in August, driven in part by lower energy price inflation, while inflation excluding food and energy remained stable at 2.3%. Inflationary pressures across major advanced economies remain muted despite the tight labour market conditions, which have so far translated into only moderate wage increases. Overall, underlying inflation pressures are expected to remain subdued over the short and medium term.

Oil prices have remained broadly unchanged amid short-term volatility. On 14 September 2019 a drone attack on Saudi Arabian oil facilities reduced the global oil supply by approximately 6%. The price of oil increased sharply in the aftermath of the attack, but had moved back to the levels seen before the attack by 30 September as Saudi Arabia used spare capacity and inventories to stabilise oil supply amid concerns about global oil demand. Non-oil commodity prices remained mixed, with metal prices having declined and food prices having increased.

In the United States, economic activity remains resilient on the whole. Real GDP expanded at an annualised rate of 2.0% in the second quarter of 2019, following 3.1% in the previous quarter. The deceleration mainly reflects the reversal of temporary factors – related to net exports and private inventories – that supported GDP growth in the first quarter. Overall, a strong labour market, sustained consumer spending and the fiscal impulse from the lifting of spending caps in the fiscal year 2020/21 are expected to support the economy in the near term, more than offsetting the signs of weakness in the manufacturing sector. Financial conditions remain supportive owing to the Federal Open Market Committee’s monetary easing. At the same time, the ongoing trade tensions and a less favourable external environment increase uncertainty about the economic outlook.

In Japan, economic activity remains subdued as weak exports offset robust domestic consumption. Real GDP grew at a quarterly rate of 0.3% in the second quarter, reflecting the rather weak underlying growth momentum. The global economic slowdown had a negative impact on Japan’s export-oriented economy, which dampened business sentiment among large manufacturers. Consumption supported growth, partly owing to frontloading ahead of the increase in the value added tax from 8% to 10% in October 2019. However, the overall personal consumption momentum remains limited amid the adverse impact of bad weather conditions, eroding consumer confidence and muted wage increases. The Bank of Japan kept monetary policy on hold in September and mentioned the need to “re-examine” economic and price developments at the October meeting. Meanwhile, inflation remained subdued, despite a tight labour market. Annual headline CPI inflation eased further to 0.2% in September, while core inflation excluding food and energy slowed to 0.3%.

In the United Kingdom, Brexit uncertainty continues to weigh on the economic outlook. Real GDP declined by 0.2% in quarter-on-quarter terms in the second quarter. This reflected, in large part, an offset to the stronger growth seen in the first quarter, which was mainly supported by stockbuilding in the run-up to the initial Brexit deadline at the end of March. Looking ahead, survey indicators suggest further weakening of consumption, business investment and export growth in the final quarters of 2019, as Brexit-related uncertainty continues to weigh on sentiment. At the same time, further fiscal spending, announced by the Government in September, is expected to put GDP growth in positive territory for the remainder of the year.

In China, GDP growth remains subdued as cyclical headwinds add to the structural slowdown. Real GDP slowed to 6.0% in year-on-year terms in the third quarter of 2019 owing to a decelerating net export contribution. Industrial production and investment softened further in August, highlighting the growing toll on Chinese manufacturers from the trade tensions with the United States. On the upside, the manufacturing PMI returned to above the neutral threshold in September, possibly signalling a bottoming-out of the manufacturing sector. In addition, car sales recovered somewhat in August from the lows in early 2019, but their annual growth remains in negative territory. Overall, China’s growth slowdown is due to both cyclical and structural factors. The structural slowdown is driven by a rebalancing of the economy away from investment, and implies a slowdown of potential growth that mainly reflects a slower pace of capital accumulation and unfavourable demographics. At the same time, cyclical headwinds, reflecting weaker manufacturing activity amid uncertainty relating to the trade tensions, add downward pressure on growth. Fiscal and monetary policy measures remain supportive, with the aim of stabilising growth.


Financial developments

Long-term sovereign yields in the euro area have increased somewhat, albeit with some fluctuations, halting the downward trend that started in late 2018. During the period under review (12 September to 23 October 2019), the GDP-weighted euro area ten-year sovereign bond yield increased by 11 basis points to 0.06% (see Chart 3), on the back of higher risk-free rates amid receding global political tensions. Ten-year sovereign bond yields in the United Kingdom also increased over the review period, to around 0.69%, while the equivalent yields in the United States decreased slightly, to 1.77%.

 

Chart 3

Ten-year sovereign bond yields

(percentages per annum)