European Central Bank — Economic Bulletin (Europe, 2018)

Economic Bulletin Issue 4 / 2018 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 Liquidity conditions and monetary policy operations in the period from 31 January to 2 May 2018 The recent slowdown in euro area output growth reflects both cyclical and temporary factors Monitoring the exchange rate pass-through to inflation The 2018 Ageing Report: population ageing poses tough fiscal challenges Country-specific recommendations for fiscal policies under the 2018 European Semester Articles 1 2 3 Foreign direct investment and its drivers: a global and EU perspective Measuring and interpreting the cost of equity in the euro area Measures of underlying inflation for the euro area Statistics ECB Economic Bulletin, Issue 4 / 2018 Contents 2 2 5 12 17 22 27 34 37 37 42 46 51 55 60 60 79 94 S1 1 Economic and monetary developments Overview At its monetary policy meeting on 14 June 2018, the Governing Council concluded that progress towards a sustained adjustment in inflation had been substantial so far. Since the start of its asset purchase programme (APP) in January 2015, the Governing Council has made net asset purchases under the APP conditional on the extent of progress towards a sustained adjustment in the path of inflation to levels below, but close to, 2% in the medium term. On 14 June 2018, the Governing Council undertook a careful review of the progress made, also taking into account the latest Eurosystem staff macroeconomic projections, measures of price and wage pressures, and uncertainties surrounding the inflation outlook. As a result of this assessment, the Governing Council concluded that progress towards a sustained adjustment in inflation has been substantial so far. With longer-term inflation expectations well anchored, the underlying strength of the euro area economy and the continuing ample degree of monetary accommodation provide grounds to be confident that the sustained convergence of inflation towards the Governing Council s aim will continue in the period ahead, and will be maintained even after a gradual winding-down of its net asset purchases. The monetary policy decisions of 14 June 2018 maintain the current ample degree of monetary accommodation that will ensure the continued sustained convergence of inflation towards levels that are below, but close to, 2% over the medium term. Significant monetary policy stimulus is still needed to support the further build-up of domestic price pressures and headline inflation developments over the medium term. This support will continue to be provided by the net asset purchases until the end of the year, by the sizeable stock of acquired assets and the associated reinvestments, and by the Governing Council s enhanced forward guidance on the key ECB interest rates. In any event, the Governing Council stands ready to adjust all of its instruments as appropriate to ensure that inflation continues to move towards the Governing Council s inflation aim in a sustained manner. Economic and monetary assessment at the time of the Governing Council meeting of 14 June 2018 Despite a slight softening of momentum, the near-term global outlook remains essentially solid, supported by accommodative monetary policies in advanced economies and significant fiscal stimulus in the United States. Further ahead, global activity is expected to slow as output is close to potential in many advanced economies. Global trade growth is seen as remaining resilient in the near term. However, the implementation of higher trade tariffs and the possibility of wider protectionist measures represent a key risk to global growth momentum. Global inflationary pressures are expected to rise slowly as spare capacity diminishes. ECB Economic Bulletin, Issue 4 / 2018   Economic and monetary developments Overview 2 Since the Governing Council s meeting in March 2018, euro area long-term risk-free rates have decreased. Sovereign bond spreads have exhibited considerable volatility since the second half of May, against a background of political uncertainty in Italy. The fluctuations in government bond markets have spilled over into other market segments to some extent and stock market volatility has increased. Equity and bond prices of euro area financial corporations have declined, while the impact on other market segments has remained limited. At the same time, stock prices of euro area non-financial corporations have risen, reflecting a robust corporate profit outlook. In foreign exchange markets, the euro has depreciated in nominal effective terms. The euro area economic expansion remains solid and broad-based across countries and sectors, despite recent weaker than expected data and indicators. Quarterly real GDP growth moderated to 0.4% in the first quarter of 2018, following growth of 0.7% in the previous quarters. This moderation reflects a pull-back from the very high levels of growth in 2017, compounded by an increase in uncertainty and some temporary and supply-side factors at both the domestic and the global level, as well as weaker impetus from external trade. The latest economic indicators and survey results are weaker, but remain consistent with ongoing solid and broad-based economic growth. The ECB s monetary policy measures, which have facilitated the deleveraging process, continue to underpin domestic demand. Private consumption is supported by ongoing employment gains, which, in turn, partly reflect past labour market reforms, and by growing household wealth. Business investment is fostered by the favourable financing conditions, rising corporate profitability and solid demand. Housing investment remains robust. In addition, the broad-based expansion in global demand is expected to continue, thus providing impetus to euro area exports. The risks surrounding the euro area growth outlook remain broadly balanced. Nevertheless, uncertainties related to global factors, including the threat of increased protectionism, have become more prominent. Moreover, the risk of persistent heightened financial market volatility warrants monitoring. The June 2018 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 2.1% in 2018, 1.9% in 2019 and 1.7% in 2020. Compared with the March 2018 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised down for 2018 and remains unchanged for 2019 and 2020. According to Eurostat s flash estimate, euro area annual HICP inflation increased to 1.9% in May 2018, from 1.2% in April. This reflected higher contributions from energy, food and services price inflation. On the basis of current futures prices for oil, annual rates of headline inflation are likely to hover around the current level for the remainder of the year. While measures of underlying inflation remain generally muted, they have been increasing from earlier lows. Domestic cost pressures are strengthening amid high levels of capacity utilisation, tightening labour markets and rising wages. Uncertainty around the inflation outlook is receding. Looking ahead, underlying inflation is expected to pick up towards the end of the year and thereafter to increase gradually over the medium term, supported by the ECB Economic Bulletin, Issue 4 / 2018   Economic and monetary developments Overview 3 ECB s monetary policy measures, the continuing economic expansion, the corresponding absorption of economic slack and rising wage growth. This assessment is also broadly reflected in the June 2018 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.7% in 2018, 2019 and 2020. Compared with the March 2018 ECB staff macroeconomic projections, the outlook for headline HICP inflation has been revised up notably for 2018 and 2019, mainly reflecting higher oil prices. The monetary analysis showed broad money growth gradually declining in the context of reduced monthly net asset purchases, with an annual rate of growth of M3 at 3.9% in April 2018, after 3.7% in March and 4.3% in February. While the slower momentum in M3 dynamics over recent months mainly reflects the reduction in the monthly net asset purchases since the beginning of the year, M3 growth continues to be supported by the impact of the ECB s monetary policy measures and the low opportunity cost of holding the most liquid deposits. Accordingly, the narrow monetary aggregate M1 remained the main contributor to broad money growth, although its annual growth rate has receded in recent months from the high rates previously observed. The pass-through of the monetary policy measures put in place since June 2014 continues to significantly support borrowing conditions for firms and households and credit flows across the euro area. This is also reflected in the results of the latest Survey on the Access to Finance of Enterprises in the euro area, which indicates that small and medium-sized enterprises in particular benefited from improved access to financing. Monetary policy decisions Based on the regular economic and monetary analyses, the Governing Council made the following decisions. First, as regards non-standard monetary policy measures, the Governing Council will continue to make net purchases under the APP at the current monthly pace of  30 billion until the end of September 2018. The Governing Council anticipates that, after September 2018, subject to incoming data confirming its medium-term inflation outlook, it will reduce the monthly pace of the net asset purchases to  15 billion until the end of December 2018 and then end net purchases. Sec