European Central Bank — Economic Bulletin (Europe, 2021)

Economic Bulletin Issue 7 / 2021 Contents Update on economic, financial and monetary developments Summary 1 2 3 4 5 External environment Financial developments Economic activity Prices and costs Money and credit Boxes 1 2 3 4 5 6 7 8 Scarring effects of the COVID-19 pandemic on the global economy   reviewing recent evidence Main findings from the ECB s recent contacts with non-financial companies Labour supply developments in the euro area during the COVID-19 pandemic The impact of the COVID-19 pandemic on labour productivity growth Economic developments and outlook for contact-intensive services in the euro area The recovery of housing demand through the lens of the Consumer Expectations Survey The prevalence of private sector wage indexation in the euro area and its potential role for the impact of inflation on wages Results of a special survey of professional forecasters on the ECB s new monetary policy strategy Articles 1 2 3 The predictive power of equilibrium exchange rate models Key factors behind productivity trends in euro area countries The euro area housing market during the COVID-19 pandemic Statistics ECB Economic Bulletin, Issue 7 / 2021   Contents 2 2 5 9 12 17 23 28 28 34 38 46 52 58 63 67 74 74 92 115 S1 1 Update on economic, financial and monetary developments Summary Economic activity At the global level, economic activity continued to expand, albeit at a measurably moderating pace, amid a combination of factors, most prominently persistent supply bottlenecks. The Purchasing Managers  Index data for August and September 2021 suggest that momentum moderated in advanced economies, although it remained above its historical average, while it was softer in emerging market economies. At the same time, global supplier delivery times remained at record highs in September, owing primarily to strong demand. World trade growth also continued to soften, albeit from still high levels. Price pressures remain elevated on account of increasing food and energy inflation, reflecting the rebound from the low price levels recorded immediately after the onset of the coronavirus (COVID-19) pandemic. Most of the price pressures are judged to be of a temporary nature. The euro area economy continued to recover strongly, although momentum moderated to some extent. Output is expected to exceed its pre-pandemic level by the end of the year. The grip of the pandemic on the economy has visibly weakened, with a high share of people now vaccinated. This is supporting consumer spending, especially on entertainment, dining, travel and transportation. But higher energy prices may reduce purchasing power in the months to come. The recovery in domestic and global demand is also supporting production and business investment. That said, shortages of materials, equipment and labour are holding back the manufacturing sector. Delivery times have lengthened considerably, and transport costs and energy prices have surged. These constraints are clouding the outlook for the coming quarters. The labour market continues to improve. Unemployment has fallen and the number of people in job retention schemes is down significantly from the peak last year. This supports the prospect of higher incomes and increased spending. But, both the number of people in the labour force and the hours worked in the economy remain below their pre-pandemic levels. To sustain the recovery, targeted and coordinated fiscal support should continue to complement monetary policy. This support will also help the economy adjust to the structural changes that are under way. An effective implementation of the Next Generation EU programme and the  Fit for 55  package will contribute to a stronger, greener and more even recovery across euro area countries. ECB Economic Bulletin, Issue 7 / 2021   Update on economic, financial and monetary developments Summary 2 Inflation Euro area inflation increased to 3.4% in September and is expected to rise further this year. But while the current phase of higher inflation will last longer than originally expected, inflation is expected to decline in the course of next year. The upswing in inflation largely reflects a combination of three factors. First, energy prices   especially for oil, gas and electricity   have risen sharply. In September, energy inflation accounted for about half of overall inflation. Second, prices are also going up because recovering demand related to the reopening of the economy is outpacing supply. These dynamics are especially visible in the prices of consumer services, as well as the prices of goods affected most strongly by supply shortages. And finally, base effects related to the end of the VAT cut in Germany are still contributing to higher inflation. The influence of all three factors is expected to ease in the course of 2022 or to fall out of the year-on-year inflation calculation. As the recovery continues, the gradual return of the economy to full capacity will underpin a rise in wages over time. Market and survey-based measures of longer-term inflation expectations have moved closer to 2%. These factors will support underlying inflation and the return of inflation to the ECB s 2% target over the medium term. Risk assessment The recovery continues to depend on the course of the pandemic and further progress with vaccinations. The Governing Council sees the risks to the economic outlook as broadly balanced. In the near term, supply bottlenecks and rising energy prices are the main risks to the pace of recovery and the outlook for inflation. If supply shortages and higher energy prices last longer, these could slow down the recovery. At the same time, if persistent bottlenecks feed through into higher than anticipated wage rises or the economy returns more quickly to full capacity, price pressures could become stronger. However, economic activity could outperform current expectations if consumers become more confident and save less than currently expected. Financial and monetary conditions Growth and medium-term inflation dynamics still depend on favourable financing conditions for all sectors of the economy. Market interest rates have increased. Nevertheless, financing conditions for the economy remain favourable, not least because bank lending rates for firms and households remain at historically low levels. The forward curve of the benchmark euro short-term rate ( STR) steepened significantly during the review period, which in part reflected market participants  repricing of an earlier rise in policy interest rates. At the same time, longer-term nominal risk-free rates   as well as sovereign bond yields   rose on the back of a marked rise in inflation compensation. Equity prices for non-financial corporations ECB Economic Bulletin, Issue 7 / 2021   Update on economic, financial and monetary developments Summary 3 and corporate bond spreads remained broadly unchanged, while bank equity prices increased. The euro depreciated in trade-weighted terms. Money creation in the euro area continued to normalise in September 2021, reflecting an improving situation regarding the pandemic and policy support measures. Eurosystem asset purchases remained the dominant source of money creation. While there was a pick-up in September, lending to firms remains moderate. This continues to reflect the fact that firms generally need less external funding, since these have high cash holdings and are increasingly retaining their earnings. Lending to households remains strong, driven by demand for mortgages. The most recent euro area bank lending survey shows that credit conditions for firms stabilised and were supported   for the first time since 2018   by a reduction in banks  risk perceptions. By contrast, banks are taking a slightly more cautious approach to housing loans and have tightened their lending standards for these loans accordingly. Bank balance sheets continue to be supported by favourable funding conditions and remain solid. Monetary policy decisions Against this background, at its monetary policy meeting in October, the Governing Council continued to judge that favourable financing conditions can be maintained with a moderately lower pace of net asset purchases under the pandemic emergency purchase programme (PEPP) than in the second and third quarters of this year. The Governing Council also confirmed its other measures to support the ECB s price stability mandate, namely the level of the key ECB interest rates, the Governing Council s forward guidance on their likely future evolution, Eurosystem purchases under the asset purchase programme (APP), the Governing Council s reinvestment policies and its longer-term refinancing operations. The Governing Council stands ready to adjust all of its instruments, as appropriate, to ensure that inflation stabilises at the ECB s 2% target over the medium term. ECB Economic Bulletin, Issue 7 / 2021   Update on economic, financial and monetary developments Summary 4 1 External environment At the global level, economic activity is decelerating owing to combination of factors, most prominently persistent supply bottlenecks. The Purchasing Managers  Index data for August and September suggest that momentum moderated in advanced economies, although it remained above its historical average, while it was softer in emerging market economies. At the same time, global supplier delivery times remained at record highs in September, owing primarily to strong demand but also reflecting persistent supply constraints. World trade growth also continued to soften, albeit from still elevated levels. Price pressures are still elevated on account of increasing food and energy inflation, r