ECB Economic Bulletin, No. 2 - 2015

With a view to pursuing the ECB’s price stability mandate, the Governing Council has taken a number of monetary policy measures to provide a sufficient degree of monetary policy accommodation. Following the monetary policy initiatives taken by the ECB between June and September 2014, which included further interest rate cuts, the introduction of targeted longerterm refinancing operations (TLTROs) and purchases of selected private sector assets (under the asset-backed securities purchase programme (ABSPP) and the third covered bond purchase programme (CBPP3)), the Governing Council decided in January 2015 to expand its asset purchase programme (APP) to encompass, as of March, euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions. The combined monthly purchases of public and private sector securities will amount to €60 billion. They are intended to be carried out until end-September 2016 and will in any case be conducted until the Governing Council sees a sustained adjustment in the path of inflation which is consistent with its aim of achieving inflation rates below, but close to, 2% over the medium term.

The asset purchase programme has already produced a substantial easing of broad financial conditions. In December 2014 and most of January 2015 financial market developments were to a large extent driven by market expectations regarding the announcement of the APP. In this context, euro area bond yields declined across instruments, maturities and issuers and in many cases reached new historical lows. Since the declines in yields on AAA-rated long-term euro area sovereign bonds coincided with increases in equivalent US bond yields, the decoupling of euro area and US government bond yields continued. Yields on lower-rated euro area sovereign bonds also fell, but were more volatile amid uncertainty about Greece’s continued access to financial assistance. Spreads on investment-grade corporate bonds continued their decline, while ABS spreads remained broadly stable. Following the APP announcement, euro area bond yields fell further, while stock prices in the euro area increased considerably. The euro’s exchange rate has weakened significantly over recent months.

Favourable developments in financial markets have led to lower bank funding costs, which have gradually been passed on to the cost of external finance for the private sector. The ECB’s monetary policy measures have resulted in an improvement in bank financing conditions, with yields on unsecured bank bonds declining to historical lows in the fourth quarter of 2014. This improvement has been gradually passed through to bank lending rates for households and non-financial corporations (NFCs), which in the third and fourth quarters of 2014 fell substantially. The reduction in bank funding costs and in bank lending rates in the second half of 2014 can be partly attributed to the TLTROs, which are designed to improve banks’ access to longer-term liquidity and stimulate credit growth in the real economy. The TLTROs should also have helped narrow margins on loans to euro area households and NFCs. In order to underpin the effectiveness of the TLTROs in supporting lending to the private sector, the Governing Council decided at its January meeting that the interest rate for the remaining TLTROs would be equal to the rate on the Eurosystem’s main refinancing operations, thus removing the 10 basis point spread over the MRO rate that applied to the first two TLTROs. The ECB’s monetary policy measures appear to have also promoted a narrowing of the cross-country dispersion of borrowing costs, especially for NFCs,
although credit conditions remain heterogeneous across countries. The nominal cost of non-bank external finance for euro area NFCs continued to decrease in the fourth quarter of 2014 and in the
first two months of 2015, as a result of a further decline in both the cost of market-based debt and the cost of equity.

Recent data also indicate a firming of money and credit dynamics. Annual growth in the broad monetary aggregate M3 is still supported by its most liquid components, with the narrow monetary aggregate M1 growing robustly. Bank lending to the private sector has continued to recover, confirming the occurrence of a turnaround in loan dynamics at the beginning of 2014. In particular, the decline in loans to NFCs has continued to moderate over recent months, while the growth of loans to households has stabilised at positive levels. Moreover, the January 2015 euro area bank lending survey confirmed the assessment that credit supply constraints were gradually receding and demand for loans was recovering. Overall, recent developments suggest that the ECB’s monetary policy measures are contributing to an easing of bank lending conditions and, more generally, to restoring the proper functioning of the monetary policy transmission mechanism.

The substantial additional easing of the ECB’s monetary policy stance supports and reinforces the emergence of more favourable developments in euro area economic activity. The economic recovery firmed gradually in the second half of 2014. Real GDP increased by 0.2%, quarter on quarter, in the third quarter of the year, and, according to Eurostat’s flash estimate, by 0.3% in the fourth quarter, which was somewhat higher than previously expected. Short-term indicators and survey results point to a further improvement in economic activity at the beginning of 2015. It appears that euro area activity has been supported by the significant fall in oil prices since July 2014. An environment of improving business and consumer sentiment will support the effective transmission of the policy measures to the real economy, contributing to a further improvement in the outlook for economic growth and a reduction in economic slack.

The economic recovery is expected to strengthen and broaden gradually. Growth in activity is expected to increase on account of the recent improvements in business and consumer confidence, the sharp fall in oil prices, the weakening of the effective exchange rate of the euro and the impact of the ECB’s recent monetary policy measures. The accommodative monetary policy stance – substantially reinforced by the APP – is expected to support real GDP growth in both the short term and beyond. Furthermore, the progress made in structural reforms and fiscal consolidation should gradually benefit the real economy. Exports should be supported by gains in price competitiveness and the global recovery.

At the same time, several obstacles to a stronger pick-up in activity persist. These include primarily the ongoing balance sheet adjustments in various sectors and the rather slow pace at which structural reforms are being implemented. In addition, diminishing but ongoing uncertainty related to the European sovereign debt crisis and geopolitical factors are dampening growth in the euro area.

The March 2015 ECB staff macroeconomic projections for the euro area,* which incorporate the estimated impact of both standard and non-standard monetary policy measures taken by the Governing Council, foresee annual real GDP increasing by 1.5% in 2015, 1.9% in 2016 and 2.1% in 2017. Compared with the December 2014 Eurosystem staff macroeconomic projections, the forecasts for real GDP growth in 2015 and 2016 have been revised upwards, reflecting the favourable impact of lower oil prices, a weaker effective exchange rate of the euro and the impact of the recent monetary policy measures. In the Governing Council’s assessment, risks to the outlook for activity remain on the downside, although they have diminished following the Governing Council’s latest decisions and the fall in oil prices.

On the basis of current information, inflation is expected to remain very low or negative over the coming months. Oil prices are a major factor behind HICP inflation having turned negative in recent months. According to Eurostat’s flash estimate, annual HICP inflation was -0.3% in February 2015 (up from -0.6% in January). At the same time, HICP inflation excluding energy and food continued on a broadly stable path, remaining at 0.6% in February.

Inflation rates are expected to gradually rise later this year. First, as past declines in energy prices will gradually drop out of the annual rate of change and provided oil prices increase over the projection horizon in line with the upward-sloping oil futures curve, the negative impact from energy prices on headline HICP should fade in 2015 and energy prices should increase headline inflation in 2016 and 2017. The expected pick-up in overall inflation is to a large part driven by this turnaround in energy prices. In addition, the increase in overall inflation should follow from the firming economic recovery, which is supported by the recent monetary policy decisions. The firming recovery is expected to result in a significant narrowing of the negative output gap and thus stronger growth of profit margins and compensation per employee. The increase in inflation should also be supported by rising non-energy commodity prices and the lagged effects of the weaker exchange rate of the euro.

The March 2015 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation at 0.0% in 2015, 1.5% in 2016 and 1.8% in 2017. Compared with the December 2014 Eurosystem staff macroeconomic projections, the forecast for inflation in 2015 has been revised down, mainly reflecting the fall in oil prices, while the projection for 2016 has been revised up, partly reflecting the expected impact of the monetary policy measures. The March 2015 ECB staff macroeconomic projections are conditional on the full implementation of the ECB’s monetary policy measures. The Governing Council will continue to closely monitor the risks to the outlook for price developments over the medium term, focusing, in particular, on the pass-through of the monetary policy measures, geopolitical developments, and exchange rate and energy price developments.

The current focus of monetary policy is on implementation of the measures decided by the Governing Council in January 2015. Based on its regular economic and monetary analyses, and in line with its forward guidance, the Governing Council decided at its meeting on 5 March 2015 to keep the ECB interest rates unchanged. It also provided further information on aspects of the implementation of the APP. Purchases of public sector securities in the secondary market under this programme started on 9 March 2015.

* See the article entitled “March 2015 ECB staff macroeconomic projections for the euro area”, published on the ECB’s website on 5 March 2015.

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