ECB Economic Bulletin, No. 6 - 2015

A review of recent data, new ECB staff macroeconomic projections and an interim evaluation of recent market fluctuations point to a continued, although somewhat weaker, economic recovery in the euro area and a slower increase in inflation rates compared with earlier expectations. The changed outlook is due to a considerable extent to external developments. While the world economy is gradually expanding, it remains on an uneven path. On the one hand, economic activity in advanced economies is being supported by low oil prices, continued accommodative financing conditions, a slower pace of fiscal consolidation and improving labour markets. On the other hand, the outlook has worsened in emerging market economies amid heightened uncertainty, as structural impediments and macroeconomic imbalances are restraining growth in some countries, while others are adjusting to lower commodity prices and less favourable external financing conditions. In parallel, inflationary pressures have been dampened by falling commodity prices.

Renewed downside risks to the outlook for growth and inflation have also emerged as a result of the recent increase in volatility in financial markets. Two significant episodes of heightened tensions occurred over the summer. The first was associated with developments in Greece in late June and early July and had, overall, a relatively muted impact on financial markets. The second episode took place in the second half of August and was related to developments in China. It had a significant impact on stock and foreign exchange markets as well as on perceptions of risk. Overall, long-term nominal euro area government bond yields declined slightly between early June and early September. Euro area stock prices declined markedly, especially amid losses in the Chinese equity market in the second half of August and the related increase in global uncertainty. In this environment of increased risk aversion and weakness in emerging markets, the effective exchange rate of the euro has recently appreciated significantly.

Euro area real GDP grew in the second quarter of 2015 at a slightly slower pace than in the first quarter. The pace of growth in the second quarter was somewhat slower than expected. The moderation was due to weaker than expected domestic demand and was broad-based across countries. The latest survey indicators suggest that the pace of real GDP growth in the second half of 2015 will be similar to that recorded in the second quarter.

Looking further ahead, the euro area recovery is expected to continue, albeit at a somewhat weaker pace than previously anticipated. This reflects in particular the slowdown in emerging market economies, which is weighing on global growth and thus on demand for euro area exports. Domestic demand should be further supported by the ECB’s monetary policy measures and their favourable impact on financial conditions, as well as by the progress made with fiscal consolidation and structural reforms. Moreover, lower oil prices should bolster households’ real disposable income and corporate profitability, providing additional support for private consumption and investment. At the same time, the necessary balance sheet adjustments in a number of sectors and the sluggish pace of implementation of structural reforms are likely to dampen the pick-up in activity.

The September 2015 ECB staff macroeconomic projections for the euro area1 foresee annual real GDP increasing by 1.4% in 2015, 1.7% in 2016 and 1.8% in 2017. Compared with the June 2015 Eurosystem staff macroeconomic projections, the outlook for real GDP growth has been revised down, primarily due to lower external demand owing to weaker growth in emerging markets. In the Governing Council’s assessment, risks to the outlook for economic activity remain on the downside, reflecting in particular the heightened uncertainties related to the external environment. Notably, current developments in emerging market economies have the potential to further affect global growth adversely via trade and confidence effects.

Following an upward trend earlier this year, HICP inflation in the euro area has recently stabilised at low positive rates. According to Eurostat’s flash estimate, annual HICP inflation remained at 0.2% in August for the third consecutive month. While low energy prices have dampened inflation, this has been compensated for by higher increases in food and non-energy industrial goods prices. Recent indicators confirm a gradual strengthening in underlying inflation. HICP excluding food and energy is estimated to have increased from a trough of 0.6% at the beginning of the year to 1.0% in August.

On the basis of the information available, annual HICP inflation rates will remain very low in the near term, mainly reflecting recent developments in energy prices. Towards the end of 2015, however, headline inflation is expected to rise, also on account of base effects associated with the fall in oil prices in late 2014. Inflation rates are foreseen to pick up further during 2016 and 2017, supported by the expected economic recovery, the pass-through of past declines in the euro exchange rate and the assumption of somewhat higher oil prices in the years ahead as reflected in oil futures markets. However, this increase in annual inflation rates is currently expected to materialise somewhat more slowly than anticipated thus far.

The September 2015 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation at 0.1% in 2015, 1.1% in 2016 and 1.7% in 2017. In comparison with the June 2015 Eurosystem staff macroeconomic projections, the outlook for HICP inflation has been revised down, largely owing to lower oil prices. Taking into account the most recent developments in oil prices and recent exchange rates, there are downside risks to the September staff inflation projections.

The ECB’s monetary policy measures continue to be transmitted to lending conditions and remain supportive of broad money and credit dynamics. The targeted longer-term refinancing operations (TLTROs) and the expanded asset purchase programme (APP) have contributed to improvements in money and credit indicators. Banks’ funding costs stabilised at historical lows in the second quarter of 2015, and favourable lending conditions continued to support a gradual recovery in loan growth. In addition, divergences in bank lending rates across euro area countries have narrowed further. The overall annual flow of external financing to non-financial corporations is estimated to have stabilised in the second quarter of 2015, although the dynamics of loans to non-financial corporations remain subdued. Stronger growth of credit to general government and a continued gradual recovery of credit to the private sector are supporting broad money growth.

The Governing Council judges it premature to conclude on whether recent economic and financial market developments could have a lasting impact on the achievement of a sustainable path of inflation towards its mediumterm aim or whether they should be considered to be mainly transitory, and will continue to closely monitor all relevant incoming information. Based on its regular economic and monetary analysis, and in line with its forward guidance, the Governing Council decided at its meeting on 3 September to keep the key ECB interest rates unchanged and confirmed that the asset purchase programme continues to proceed smoothly. Looking ahead, the Governing Council will closely monitor the risks to the outlook for price developments over the medium term, focusing in particular on the pass-through of its monetary policy measures, as well as on global economic, financial, commodity price and exchange rate developments.

The Governing Council emphasises its willingness and ability to act, if warranted, by using all the instruments available within its mandate and, in particular, recalls that the asset purchase programme provides sufficient flexibility in terms of adjusting the size, composition and duration of the programme. In the meantime, the Eurosystem will fully implement its monthly asset purchases of €60 billion, which are intended to run until the end of September 2016, or beyond, if necessary, and, in any case, 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 Governing Council reiterates the need to firmly implement its monetary policy decisions and to monitor closely all relevant incoming information as concerns their impact on the medium-term outlook for price stability.

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