European Central Bank — Economic Bulletin (Europe, 2021)

Economic Bulletin Issue 2 / 2021 Contents Economic and monetary developments Overview 1 2 3 4 5 6 External environment Financial developments Economic activity Prices and costs Money and credit Fiscal developments Boxes 1 2 3 4 5 6 7 Economic developments in the euro area and the United States in 2020 The euro area capital stock since the beginning of the COVID-19 pandemic Liquidity conditions and monetary policy operations from 4 November 2020 to 26 January 2021 The impact of containment measures across sectors and countries during the COVID-19 pandemic The role of profit margins in the adjustment to the COVID-19 shock 2021 HICP weights and their implications for the measurement of inflation Towards an effective implementation of the EU s recovery package Articles 1 2 3 Monetary policy and inequality Making sense of consumers  inflation perceptions and expectations   the role of (un)certainty The paradox of banknotes: understanding the demand for cash beyond transactional use Statistics ECB Economic Bulletin, Issue 2 / 2021   Contents 2 2 7 15 20 26 32 40 44 44 50 56 62 69 75 80 84 84 104 121 S1 1 Economic and monetary developments Overview While the overall economic situation is expected to improve over 2021, there remains uncertainty surrounding the near-term economic outlook, relating in particular to the dynamics of the coronavirus (COVID-19) pandemic and the speed of vaccination campaigns. The rebound in global demand and additional fiscal measures are supporting global and euro area activity. But persistently high infection rates, the spread of virus mutations, and the associated extension and tightening of containment measures are weighing on euro area economic activity in the short term. Looking ahead, the ongoing vaccination campaigns, together with the envisaged gradual relaxation of containment measures, underpin the expectation of a firm rebound in economic activity in the course of 2021. Inflation has picked up over recent months mainly on account of some transitory factors and an increase in energy price inflation. At the same time, underlying price pressures remain subdued in the context of weak demand and significant slack in labour and product markets. While the latest staff projection exercise foresees a gradual increase in underlying inflation pressures, it confirms that the medium-term inflation outlook remains broadly unchanged from the staff projections in December 2020 and below the Governing Council s inflation aim. In these conditions, preserving favourable financing conditions over the pandemic period remains essential. The Governing Council assesses financing conditions by looking at a holistic and multifaceted set of indicators, spanning the entire transmission chain of monetary policy from risk-free interest rates and sovereign yields to corporate bond yields and bank credit conditions. Market interest rates have increased since the start of the year, which poses a risk to wider financing conditions. Banks use risk-free interest rates and sovereign bond yields as key references for determining credit conditions. If sizeable and persistent, increases in these market interest rates, when left unchecked, could translate into a premature tightening of financing conditions for all sectors of the economy. This is undesirable at a time when preserving favourable financing conditions still remains necessary to reduce uncertainty and bolster confidence, thereby underpinning economic activity and safeguarding medium-term price stability. Against this background and based on a joint assessment of financing conditions and the inflation outlook, the Governing Council expects purchases under the pandemic emergency purchase programme (PEPP) over the next quarter to be conducted at a significantly higher pace than during the first months of this year. Economic and monetary assessment at the time of the Governing Council meeting of 11 March 2021 The global economy rebounded from the recession induced by the coronavirus pandemic faster than expected in the December 2020 Eurosystem staff ECB Economic Bulletin, Issue 2 / 2021   Economic and monetary developments Overview 2 macroeconomic projections. Meanwhile, headwinds to growth intensified as the pandemic worsened at the turn of the year. A resurgence in new infections led governments to reimpose stringent lockdowns, particularly in advanced economies. The adverse impact of these measures on global growth is already visible in incoming data. The pandemic remains the key factor shaping economic developments looking ahead. Vaccination efforts have gradually gathered pace, although at varying speeds across countries. However, the level of immunisation is still too low to allow the containment measures to be lifted. The fiscal stimulus package in the United States approved last December and the EU-UK trade deal support the outlook for the euro area s external environment this year. Global GDP growth (excluding the euro area) is projected to be 6.5% in 2021, before decelerating to 3.9% in 2022 and 3.7% in 2023. This follows the estimated 2.4% contraction in global GDP in 2020. The EU-UK trade deal and the stronger projected recovery in advanced economies explain the upward revisions to euro area foreign demand. It is projected to increase by 8.3% this year and by 4.4% and 3.2% in 2022 and 2023 respectively, implying upward revisions of 1.7 percentage points in 2021 and 0.3 percentage points in 2022. Risks to the baseline projections for global growth are tilted to the upside, as the additional fiscal stimulus planned by President Biden represents a key upside risk. Model simulations suggest that it will raise the level of real GDP in the United States by 2-3% and take the economy above its potential, although the impact on inflation is likely to be moderate. Financial conditions in the euro area have tightened somewhat since the Governing Council s meeting in December 2020, amid positive risk sentiment. Over the review period (10 December 2020 to 10 March 2021) the forward curve of the euro overnight index average (EONIA) shifted upwards and became steeper. Currently, the forward curve does not signal expectations of a rate cut in the very near term. Euro area long-term sovereign bond spreads remained stable, as the rise in yields was driven by the increase in risk-free rates, supported by robust risk sentiment underpinned by monetary and fiscal stimulus. The prices of risk assets increased accordingly. In foreign exchange markets, the nominal effective exchange rate of the euro weakened slightly. Following the strong rebound in growth in the third quarter of 2020, euro area real GDP declined by 0.7% in the fourth quarter. Looking at the full year, real GDP is estimated to have contracted by 6.6% in 2020, with the level of economic activity for the fourth quarter of the year standing 4.9% below its pre-pandemic level at the end of 2019. Incoming economic data, surveys and high-frequency indicators point to continued economic weakness in the first quarter of 2021 driven by the persistence of the pandemic and the associated containment measures. As a result, real GDP is likely to contract again in the first quarter of the year. Economic developments continue to be uneven across countries and sectors, with the services sector being more adversely affected by the restrictions on social interaction and mobility than the industrial sector, which is recovering more quickly. Although fiscal policy measures are supporting households and firms, consumers remain cautious in the light of the pandemic and its impact on employment and earnings. Moreover, weaker corporate balance sheets and elevated uncertainty about the economic outlook are still weighing on business investment. ECB Economic Bulletin, Issue 2 / 2021   Economic and monetary developments Overview 3 Looking ahead, the ongoing vaccination campaigns, together with the gradual relaxation of containment measures   barring any further adverse developments related to the pandemic   underpin the expectation of a firm rebound in economic activity in the course of 2021. Over the medium term, the recovery of the euro area economy should be supported by favourable financing conditions, an expansionary fiscal stance and a recovery in demand as containment measures are gradually lifted. This assessment is broadly reflected in the baseline scenario of the March 2021 ECB staff macroeconomic projections for the euro area. These projections foresee annual real GDP growth at 4.0% in 2021, 4.1% in 2022 and 2.1% in 2023. Compared with the December 2020 Eurosystem staff macroeconomic projections, the outlook for economic activity is broadly unchanged. Overall, the risks surrounding the euro area growth outlook over the medium term have become more balanced, although downside risks remain in the near term. On the one hand, better prospects for global demand, bolstered by the sizeable fiscal stimulus, and the progress in vaccination campaigns are encouraging. On the other hand, the ongoing pandemic, including the spread of virus mutations, and its implications for economic and financial conditions continue to be sources of downside risk. Euro area annual inflation increased sharply to 0.9% in January and February 2021, up from -0.3% in December 2020. The upswing in headline inflation reflects a number of idiosyncratic factors, such as the end of the temporary VAT rate reduction in Germany, delayed sales periods in some euro area countries and the impact of the stronger than usual changes in HICP weights for 2021, as well as higher energy price inflation. On the basis of current oil futures prices, headline inflation is likely