European Central Bank — Economic Bulletin (Europe, 2023)

Economic Bulletin Issue 3 / 2023 Contents Contents Update on economic, financial and monetary developments Summary External environment Economic activity Prices and costs Financial market developments Financing conditions and credit developments 1 2 3 4 5 Boxes 1 2 3 4 5 6 7 8 Monetary policy and housing investment in the euro area and the United States Intangible assets of multinational enterprises in Ireland and their impact on euro area GDP The energy shock, price competitiveness and euro area export performance Main findings from the ECB s recent contacts with non-financial companies Indicators for producer price pressures in consumer goods inflation A model-based assessment of the macroeconomic impact of the ECB s monetary policy tightening since December 2021 Government expenditure in the euro area during the pandemic crisis   insights from the Classification of the Functions of Government data EUROPOP2023 demographic trends and their euro area economic implications Articles 1 2 The impact of Brexit on UK trade and labour markets The impact of the recent inflation surge across households Economic Bulletin, Issue 3/2023   Contents 1 3 3 7 12 19 25 28 35 35 41 47 52 55 61 68 72 78 78 99 1 Box 1 How consumer behaviour changes with inflation Box 2 Inflation, fiscal policy and inequality Statistics 104 109 S1 Economic Bulletin, Issue 3/2023   Contents 2 Update on economic, financial and monetary developments Summary The inflation outlook continues to be too high for too long. In light of the ongoing high inflation pressures, the Governing Council decided at its meeting on 4 May 2023 to raise the three key ECB interest rates by 25 basis points. Overall, the incoming information broadly supports the assessment of the medium-term inflation outlook that the Governing Council formed at its previous monetary policy meeting on 16 March. Headline inflation has declined over recent months, but underlying price pressures remain strong. At the same time, the past rate increases are being transmitted forcefully to euro area financing and monetary conditions, while the lags and strength of transmission to the real economy remain uncertain. The Governing Council s future decisions will ensure that the policy rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to its 2% medium-term target and will be kept at those levels for as long as necessary. The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, the policy rate decisions will continue to be based on the Governing Council s assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. The key ECB interest rates remain the Governing Council s primary tool for setting the monetary policy stance. In parallel, the Governing Council will keep reducing the Eurosystem s asset purchase programme (APP) portfolio at a measured and predictable pace. In line with these principles, the Governing Council expects to discontinue the reinvestments under the APP as of July 2023. Economic activity Global economic activity was stronger than expected in early 2023. The global economy was supported by China s economic reopening after the end of its zero- COVID policy, along with resilience in the US labour market   significant monetary policy tightening notwithstanding. Trade, however, remained relatively weak as the recovery in activity was concentrated in less trade-intensive demand components, such as services. Global headline inflation continues to recede, while core inflation remains at elevated levels. The euro area economy grew by 0.1% in the first quarter of 2023, according to Eurostat s preliminary flash estimate. Lower energy prices, the easing of supply bottlenecks and fiscal policy support for firms and households have contributed to Economic Bulletin, Issue 3/2023   Update on economic, financial and monetary developments Summary 3 the resilience of the economy. At the same time, private domestic demand, especially consumption, is likely to have remained weak. Business and consumer confidence have recovered steadily in recent months but remain weaker than before Russia s unjustified war against Ukraine and its people. The Governing Council sees a divergence across sectors of the economy. The manufacturing sector is working through a backlog of orders, but its prospects are worsening. The services sector is growing more strongly, especially owing to the reopening of the economy. Household incomes are benefiting from the strength of the labour market, with the unemployment rate falling to a new historical low of 6.5% in March. Employment has continued to grow and total hours worked exceed pre-pandemic levels. At the same time, the average number of hours worked remains somewhat below its pre- pandemic level and its recovery has stalled since mid-2022. As the energy crisis fades, governments should roll back the related support measures promptly and in a concerted manner to avoid driving up medium-term inflationary pressures, which would call for a stronger monetary policy response. Fiscal policies should be oriented towards making the euro area economy more productive and gradually bringing down high public debt. Policies to enhance the euro area s supply capacity, especially in the energy sector, can also help reduce price pressures in the medium term. In this regard, the Governing Council welcomes the publication of the European Commission s legislative proposals for the reform of the EU s economic governance framework, which should be concluded soon. Inflation According to Eurostat s flash estimate, inflation was 7.0% in April, after having dropped from 8.5% in February to 6.9% in March. While base effects led to some increase in energy price inflation, from -0.9% in March to 2.5% in April, the rate stands far below those recorded after the start of Russia s war against Ukraine. Food price inflation remains elevated, however, standing at 13.6% in April, after 15.5% in March. Price pressures remain strong. Inflation excluding energy and food was 5.6% in April, having edged down slightly compared with March to return to its February level. Non-energy industrial goods inflation fell to 6.2% in April, from 6.6% in March, when it declined for the first time in several months. But services inflation increased to 5.2% in April, from 5.1% in March. Inflation is still being pushed up by the gradual pass-through of past energy cost increases and supply bottlenecks. In services, especially, it is still being pushed higher also by pent-up demand from the reopening of the economy and by rising wages. The information available up to March suggests that indicators of underlying inflation remain high. Wage pressures have strengthened further as employees, in a context of a robust labour market, recoup some of the purchasing power they have lost as a result of high inflation. Moreover, in some sectors firms have been able to increase their profit Economic Bulletin, Issue 3/2023   Update on economic, financial and monetary developments Summary 4 margins on the back of mismatches between supply and demand and the uncertainty created by high and volatile inflation. Although most measures of longer-term inflation expectations currently stand at around 2%, some indicators have edged up and warrant continued monitoring. Risk assessment Renewed financial market tensions, if persistent, would pose a downside risk to the outlook for growth as they could tighten broader credit conditions more strongly than expected and dampen confidence. Russia s war against Ukraine also continues to be a significant downside risk to the economy. However, the recent reversal of past adverse supply shocks, if sustained, could spur confidence and support higher growth than currently expected. The continued resilience of the labour market, by bolstering household confidence and spending, could also lead to higher growth than anticipated. There are still significant upside risks to the inflation outlook. These include existing pipeline pressures that could send retail prices higher than expected in the near term. Moreover, Russia s war against Ukraine could again push up the costs of energy and food. A lasting rise in inflation expectations above the Governing Council s target, or higher than anticipated increases in wages or profit margins, could also drive inflation higher, including over the medium term. Recent negotiated wage agreements have added to the upside risks to inflation, especially if profit margins remain high. The downside risks include renewed financial market tensions, which could bring inflation down faster than projected. Weaker demand, due for example to a more marked slowing of bank lending or a stronger transmission of monetary policy, would also lead to lower price pressures than currently anticipated, especially over the medium term. Financial and monetary conditions The euro area banking sector has proved resilient in the face of the financial market tensions that arose ahead of the Governing Council s meeting in March. The Governing Council s policy rate increases are being transmitted strongly to risk-free interest rates and to the financing conditions for firms, households and banks. For firms and households, loan growth has weakened owing to higher borrowing rates, tighter credit supply conditions and lower demand. The latest euro area bank lending survey reported a tightening of overall credit standards, which was stronger than banks had ex