European Central Bank — Economic Bulletin (Europe, 2022)

Economic Bulletin Issue 7 / 2022 Contents Update on economic, financial and monetary developments Summary 1 2 3 4 5 External environment Economic activity Prices and costs Financial market developments Financing conditions and credit developments Boxes 1 2 3 4 5 6 7 8 Supply bottlenecks and price pressures in euro area goods trade and tourism Motor vehicle sector: explaining the drop in output and the rise in prices Carry-over effects and intra-quarter GDP growth   estimates based on monthly indicators The impact of the recent rise in inflation on low-income households Main findings from the ECB s recent contacts with non-financial companies A closer look at consumers  inflation expectations   evidence from the ECB s Consumer Expectations Survey The role of demand and supply in underlying inflation   decomposing HICPX inflation into components Euro area linkages with Russia: latest insights from the balance of payments Articles 1 Risk sharing in the euro area: a focus on the public channel and the COVID-19 pandemic Statistics ECB Economic Bulletin, Issue 7 / 2022   Contents 2 2 7 13 21 26 29 37 37 44 52 55 61 64 70 76 81 81 S1 1 Update on economic, financial and monetary developments Summary At its meeting on 27 October 2022, the Governing Council decided to raise the three key ECB interest rates by 75 basis points. With this third major policy rate increase in a row, the Governing Council has made substantial progress in withdrawing monetary policy accommodation. The Governing Council took its decision, and expects to raise interest rates further, to ensure the timely return of inflation to the ECB s 2% medium-term inflation target. The Governing Council will base the future policy rate path on the evolving outlook for inflation and the economy, following its meeting-by-meeting approach. Inflation remains far too high and will stay above the target for an extended period. In September, euro area inflation reached 9.9%. In recent months, soaring energy and food prices, supply bottlenecks and the post-pandemic recovery in demand have led to a broadening of price pressures and an increase in inflation. The Governing Council s monetary policy is aimed at reducing support for demand and guarding against the risk of a persistent upward shift in inflation expectations. The Governing Council also decided to change the terms and conditions of the third series of targeted longer-term refinancing operations (TLTRO III). During the acute phase of the pandemic, this instrument played a key role in countering downside risks to price stability. Now, in view of the unexpected and extraordinary rise in inflation, it needs to be recalibrated to ensure that it is consistent with the broader monetary policy normalisation process and to reinforce the transmission of policy rate increases to bank lending conditions. The Governing Council therefore decided to adjust the interest rates applicable to TLTRO III from 23 November 2022 and to offer banks additional voluntary early repayment dates. The recalibration of the TLTRO III terms and conditions will contribute to the normalisation of bank funding costs. The ensuing normalisation of financing conditions, in turn, will exert downward pressure on inflation, contributing to restoring price stability over the medium term. The recalibration also removes deterrents to early voluntary repayment of outstanding TLTRO III funds. Earlier voluntary repayments would reduce the Eurosystem balance sheet and, with that, contribute to the overall monetary policy normalisation. Finally, in order to align the remuneration of minimum reserves held by credit institutions with the Eurosystem more closely with money market conditions, the Governing Council decided to set the remuneration of minimum reserves at the ECB s deposit facility rate. ECB Economic Bulletin, Issue 7 / 2022   Update on economic, financial and monetary developments Summary 2 Economic activity Global economic activity contracted in the second quarter of 2022, with survey data indicating that a subdued growth momentum will continue in the near term. Although there are some tailwinds for the world economy from the further easing of global supply chain pressures owing to improvements in supply and weakening of demand, downside risks persist. These are associated with continuing geopolitical uncertainty, in particular potential disruptions related to Russia s unjustified war against Ukraine and a possible worsening of coronavirus (COVID-19) developments in the autumn and winter. Despite easing supply chain pressures, global trade momentum remains moderate amid the deteriorating global economic outlook. Economic activity in the euro area is likely to have slowed significantly in the third quarter of 2022, and the Governing Council expects a further weakening in the remainder of 2022 and the beginning of 2023. By reducing people s real incomes and pushing up costs for firms, high inflation continues to dampen spending and production. Severe disruptions in the supply of gas have worsened the situation further, and both consumer and business confidence have fallen rapidly, which is also weighing on the economy. Demand for services is slowing, after a strong performance in previous quarters when those sectors most affected by the pandemic-related restrictions reopened, and survey-based indicators for new orders in the manufacturing sector are falling. Moreover, global economic activity is growing more slowly, in a context of persistent geopolitical uncertainty, especially owing to the war in Ukraine, and tighter financing conditions. Worsening terms of trade, as the prices paid for imports rise faster than those received for exports, are weighing on incomes in the euro area. The labour market continued to perform well in the third quarter, and the unemployment rate remained at the historically low level of 6.6% in August. While short-term indicators suggest that jobs were still being created in the third quarter, the weakening of the economy could lead to somewhat higher unemployment in the future. To limit the risk of fuelling inflation, fiscal support measures to shield the economy from the impact of high energy prices should be temporary and targeted at the most vulnerable. Policymakers should provide incentives to lower energy consumption and bolster energy supply. At the same time, governments should pursue fiscal policies that show they are committed to gradually bringing down high public debt ratios. Structural policies should be designed to increase the euro area s growth potential and supply capacity and to boost its resilience, thereby contributing to a reduction in medium-term price pressures. The swift implementation of the investment and structural reform plans under the Next Generation EU programme will make an important contribution to these objectives. ECB Economic Bulletin, Issue 7 / 2022   Update on economic, financial and monetary developments Summary 3 Inflation Inflation rose to 9.9% in September, reflecting further increases in all components. Energy price inflation, at 40.7%, remained the main driver of overall inflation, with an increasing contribution from gas and electricity prices. Food price inflation also rose further, to 11.8%, as high input costs made food production more expensive. Supply bottlenecks are gradually easing, though their lagged impact is still contributing to inflation. The impact of pent-up demand, while weakening, is still driving up prices in the services sector. The depreciation of the euro has added to the build-up of inflationary pressures. Price pressures are evident in more and more sectors, in part owing to the impact of high energy costs feeding through to the whole economy. Measures of underlying inflation have thus remained at elevated levels. Among those measures, inflation excluding energy and food rose further to 4.8% in September. Strong labour markets are likely to support higher wages, as is some catch-up in wages to compensate for higher inflation. Incoming wage data and recent wage agreements indicate that the growth of wages may be picking up. Most measures of longer-term inflation expectations currently stand at around 2%, although further above-target revisions to some indicators warrant continued monitoring. Risk assessment The incoming data confirm that risks to the economic growth outlook are clearly on the downside, especially in the near term. A long-lasting war in Ukraine remains a significant risk. Confidence could deteriorate further and supply-side constraints could worsen again. Energy and food costs could also remain persistently higher than expected. A weakening world economy could be an additional drag on growth in the euro area. The risks to the inflation outlook are primarily on the upside. The major risk in the short term is a further rise in retail energy prices. Over the medium term, inflation may turn out to be higher than expected if there are increases in the prices of energy and food commodities and a stronger pass-through to consumer prices, a persistent worsening of the production capacity of the euro area economy, a persistent rise in inflation expectations above the Governing Council s target, or higher than anticipated wage rises. By contrast, a decline in energy costs and a further weakening of demand would lower price pressures. Financial and monetary conditions Bank funding costs are increasing in response to the rise in market interest rates. Borrowing has also become more expensive for firms and households. Bank lending to firms remains robust, as they need to finance high production costs and build up inventories. At the same time, demand for loans to finance investment h