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Update on economic and monetary developments

Summary

Incoming information since the last Governing Council meeting in early December is in line with the Governing Council’s baseline scenario of ongoing, but moderate, growth of the euro area economy. In particular, the weakness in the manufacturing sector remains a drag on euro area growth momentum. At the same time, ongoing, albeit decelerating, employment growth and increasing wages continue to support the resilience of the euro area economy. The risks surrounding the euro area growth outlook, related to geopolitical factors, rising protectionism and vulnerabilities in emerging markets, remain tilted to the downside, but have become less pronounced as some of the uncertainty surrounding international trade is receding. While inflation developments remain subdued overall, there are some signs of a moderate increase in underlying inflation in line with expectations. Against this background, the Governing Council kept its monetary policy stance unchanged at its meeting on 23 January 2020. The unfolding monetary policy measures are underpinning favourable financing conditions for all sectors of the economy. In particular, easier borrowing conditions for firms and households are supporting consumer spending and business investment. This will sustain the euro area expansion, the build-up of domestic price pressures and, thus, the robust convergence of inflation to the Governing Council’s medium-term aim.

Global economic activity remains moderate, but there are signs of stabilisation. In particular, the global manufacturing sector firmed in the last quarter of 2019, while the services sector remained broadly stable. Global trade remains weak amid signs of stabilisation. A preliminary trade deal between China and the United States has led to an easing of trade tensions, which should contribute to removing impediments to trade growth. Looking ahead, global inflationary pressures are expected to remain contained, while the balance of risks to global economic activity, although less pronounced, remains tilted to the downside.

Since the Governing Council meeting in December 2019, movements in euro area financial markets have been limited, with asset prices continuing to be supported by accommodative monetary policy and improved risk sentiment as trade tensions have further receded. Long-term risk-free rates are broadly unchanged and the EONIA forward curve has shifted slightly upwards, continuing to signal market expectations of an unchanged deposit facility rate in the coming months. Sovereign spreads have remained broadly stable over this period. Equity prices have increased amid lower risk premia, and corporate bond spreads have decreased slightly. In foreign exchange markets, the euro has weakened slightly in trade-weighted terms.

Euro area real GDP increased by 0.3%, quarter on quarter, in the third quarter of 2019, following growth of 0.2% in the second quarter. This pattern of moderate growth reflects the ongoing weakness of international trade in an environment of continued global uncertainties, which has particularly affected the euro area manufacturing sector and has also dampened investment growth. At the same time, the services and construction sectors remain more resilient, despite some moderation in the latter half of 2019. Incoming economic data and survey information point to some stabilisation in euro area growth dynamics, with near-term growth expected to be similar to rates observed in previous quarters. Looking ahead, the euro area expansion will continue to be 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 increased to 1.3% in December 2019, from 1.0% in November, reflecting mainly higher energy price inflation. On the basis of current futures prices for oil, headline inflation is likely to hover around current levels in the coming months. While indicators of inflation expectations remain at low levels, recently they have either stabilised or ticked up slightly. Measures of underlying inflation have remained generally muted, although there are further indications of a moderate increase in line with previous expectations. 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 solid wage growth.

Regarding monetary developments, broad money (M3) growth stood at 5.6% in November 2019, broadly unchanged since August. M3 growth continues to be backed up by bank credit creation and the narrow monetary aggregate M1 remained the main contributor to broad money growth. The growth of loans to firms and households remained solid, benefiting from the ongoing support provided by the ECB’s accommodative monetary policy stance, which is reflected in very low bank lending rates. While the annual growth rate of loans to households remained unchanged from October, at 3.5% in November, the annual growth rate of loans to non-financial corporations moderated to 3.4%, from 3.8% in October, likely reflecting some lagged reaction to the past weakening in the economy. However, credit standards for both loans to firms and loans to households for house purchase remained broadly unchanged, pointing to still favourable credit supply conditions. The Governing Council’s accommodative monetary policy stance will help to safeguard favourable bank lending conditions and will continue to support access to financing across all economic sectors and 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 robust 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 continue to make net purchases under the ECB’s asset purchase programme (APP) at a monthly pace of €20 billion. It expects them to run for as long as necessary to reinforce the accommodative impact of the ECB 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.

In the light of the continued subdued inflation outlook, 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. 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.

The Governing Council also decided to launch a review of the ECB’s monetary policy strategy. The review will encompass the quantitative formulation of price stability, the monetary policy toolkit, the economic and monetary analyses and communication practices. Other considerations, such as financial stability, employment and environmental sustainability, will also be part of the review, which is expected to be concluded by the end of 2020. The review will be based on thorough analysis and open minds. Accordingly, the Eurosystem will engage with all stakeholders.


External environment

The outlook for global economic activity (excluding the euro area) remains subdued but has been showing signs of stabilisation. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area increased moderately in December. The manufacturing component in particular recovered in the fourth quarter, signalling a firming of global manufacturing activity, which had gradually weakened since early 2018. The services sector remained resilient and grew further in December (see Chart 1).

 

Chart 1

Global output PMI (excluding the euro area)

(diffusion indices)

48 50 52 54 56 58 2013 2014 2015 2016 2017 2018 2019 Composite Services Manufacturing

Sources: Markit and ECB calculations.
Notes: The latest observations are for December 2019.

Risks to the global outlook remain elevated but are less skewed to the downside. The partial US‑China trade agreement represents a welcome easing of trade tensions. The so-called “Phase 1” deal includes a commitment from China to purchase a substantial amount of a broad range of US agricultural and other goods and services, which may affect demand for EU exports to China. It also aims to bring about changes in areas ranging from exchange rate policy to intellectual property protection and technology transfer. The US Trade Representative has clarified that certain existing tariffs will be reduced – including the September 2019 tariffs, which will be halved – and that the planned December 2019 tariffs will be postponed indefinitely. Moreover, China has dropped duties that were to come into effect alongside the US tariffs previously scheduled for December and will continue to hold back from introducing retaliatory tariffs on US-made automobiles and auto parts.

Financial conditions continued to loosen on the back of easing trade tensions. Financial conditions remain very loose by historical standards. In advanced economies this dynamic is partly related to the exceptional response by central banks to the Great Recession of 2007‑09 and the relatively weak global economic performance in recent years. In emerging markets, financial conditions also remain accommodative but have not eased to the same extent on account of the current broad-based strength of the US dollar. Looking ahead, in 2020 financial conditions will benefit from anchored inflation rate expectations, firms’ expectations of earnings growth in the United States and other major economies, and a possible further easing of trade tensions.

The global trade momentum remains weak, albeit amid signs of stabilisation. Global merchandise imports continued to increase moderately in October, while the global PMI for new export orders excluding the euro area continued to recover in December. For the fourth quarter as a whole, the global PMI for new export orders increased significantly relative to the third quarter, with the index nearing the neutral threshold (see Chart 2). The recent easing of trade tensions further serves to remove impediments to global trade activity. In line with this outlook, high frequency trade data are, on balance, consistent with low but positive growth in world trade.

 

Chart 2

Surveys and global trade in goods (excluding the euro area)

(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 2013 2014 2015 2016 2017 2018 2019 Global merchandise imports (left-hand scale) Average global merchandise imports, 1991-2018 (left-hand scale) Global PMI, manufacturing output (right-hand scale) Global PMI, new export orders (right-hand scale)

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

Global inflation rose further in November. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) increased to 1.8% in November, driven in part by high food price inflation in selected emerging market economies, including China and India. Meanwhile, inflation excluding energy and food increased only marginally to 2.1% in November, from 2.0% in the previous month. Looking ahead, global inflationary pressures are expected to remain contained. Wage growth in advanced economies continues to be moderate despite a tightening of labour markets and rising capacity constraints.

Oil markets have remained broadly stable. Oil prices were supported only temporarily by the OPEC+ group of major oil producers, who extended their production cuts in early December. Prices spiked at around USD 70 per barrel in early January, following a rise in tensions in the Middle East, but fell back quickly after tensions eased. With high levels of inventories and US shale oil production, together with the International Energy Agency projecting global oil demand to slow in the first quarter of 2020, oil markets are expected to remain well supplied despite the recent OPEC+ agreement. Total non-oil prices increased slightly (+1.7%) as both metal prices (+1.2%) and food prices rose (+2.8%).

Economic growth in the United States remained moderate in the third quarter of 2019. Annualised US real GDP growth stood at 2.1%. Despite the modest pick-up in activity from second quarter growth of 2.0%, economic activity moderated as a result of weak investment, the fading effect of the 2018 tax reform and the maturing business cycle. Risks to the outlook have eased somewhat but are still tilted to the downside. While trade tensions with China have eased, the recent announcement by Boeing to halt, indefinitely, the production of its 737 MAX in January represents a new risk. The net impact on the economy so far has been modest, as a decline in deliveries has been offset by accumulating inventories. Looking ahead, however, weakness in the manufacturing sector is likely to persist. Apart from the issues at Boeing, prolonged trade uncertainties, subdued global growth and the broad-based appreciation of the US dollar in recent years continue to weigh on the economy.

In Japan, the government has prepared a stimulus package to support economic growth. In early December, the government of Prime Minister Abe announced a fiscal package to tackle downside risks to activity stemming from a weak external environment and recent natural disasters. Under the package, fiscal spending amounts to 2.4% of GDP, which puts it among the largest fiscal stimulus packages enacted under “Abenomics”. The package will largely be implemented in 2020‑21. It should be noted that the impact of the package on the economy partially offsets the recent increase in VAT. In addition, weak manufacturing pushed growth into negative territory in the last quarter of 2019. The economy is expected to return to moderate positive growth in early 2020 as the impact of transitory factors dissipates and fiscal spending takes effect. Consumer price inflation has accelerated slightly. Annual headline inflation increased to 0.5% in November. Looking ahead, subdued wage growth and expectations of stable inflation at low levels imply a weak reflation momentum in the economy.

In the United Kingdom, economic activity appears to have slowed progressively over the fourth quarter of 2019. Confidence indicators remain subdued and well below their historical averages. The outcome of the December election and the large majority obtained by Prime Minister Johnson remove the short-term risk of a no-deal Brexit at the end of January, as the Withdrawal Agreement has now become law. However, the United Kingdom is facing a tight deadline to reach an agreement on its future relationship with the European Union towards the end of 2020, and therefore policy uncertainty remains high.

The preliminary trade agreement between the United States and China removes some of the obstacles to Chinese economic activity and trade. China’s economy is showing signs of stabilisation and should benefit from the Phase 1 trade deal with the United States. The trade agreement can further support growth by improving net trade and lowering trade-related uncertainty. Meanwhile, annual headline CPI inflation stabilised in December at 4.5% but remained above the official target. The December reading remained elevated owing to ongoing high food price inflation stemming from the outbreak of African swine fever and its impact on pork prices. The latter rose by 97% in year-on-year terms in December, down from 110% in November. At the same time, CPI inflation excluding energy and food remained unchanged at 1.4% in December.


Financial developments

Long-term sovereign yields in the euro area were broadly unchanged over the review period amid some volatility, following the large decrease in 2019. Over the period under review (12 December 2019 to 22 January 2020), the GDP-weighted euro area ten-year sovereign bond yield decreased by 1 basis point to 0.20% (see Chart 3). There was some volatility, however, with easing trade tensions following the signing of a “phase 1” US‑China trade deal and increasing geopolitical tensions between the United States and Iran. Ten-year sovereign bond yields in both the United Kingdom and the United States decreased slightly over the review period, to 0.63% and 1.77% respectively.

 

Chart 3

Ten-year sovereign bond yields

(percentages per annum)