European Central Bank — Economic Bulletin (Europe, 2020)

Economic Bulletin Issue 3 / 2020 Contents Update on economic 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 Articles 1 2 Statistics Alternative scenarios for the impact of the COVID-19 pandemic on economic activity in the euro area The fall in manufacturing and services activity in the euro area: foreign versus domestic shocks Disentangling aggregate and sectoral shocks Inflation measurement in times of economic distress The transmission of exchange rate changes to euro area inflation Negative rates and the transmission of monetary policy 2 2 6 10 13 18 21 25 25 31 36 39 44 44 61 S1 ECB Economic Bulletin, Issue 3 / 2020   Contents 1 Update on economic and monetary developments Summary The euro area is facing an economic contraction of a magnitude and speed that are unprecedented in peacetime. Measures to contain the spread of the coronavirus (COVID-19) have largely halted economic activity in all the countries of the euro area and across the globe. Survey indicators for consumer and business sentiment have plunged, suggesting a sharp contraction in economic growth and a profound deterioration in labour market conditions. Given the high uncertainty surrounding the ultimate extent of the economic fallout, growth scenarios produced by ECB staff suggest that euro area GDP could fall by between 5% and 12% this year, depending crucially on the duration of the containment measures and the success of policies to mitigate the economic consequences for businesses and workers. As the containment measures are gradually lifted, these scenarios foresee a recovery in economic activity, although its speed and scale remain highly uncertain. Inflation has declined as a result of the sharp fall in oil prices and slightly lower HICP inflation excluding energy and food. In its determination to continue to support the euro area economy in the face of the current economic disruption and heightened uncertainty, the Governing Council decided to further ease the conditions on the targeted longer-term refinancing operations (TLTRO III) and to launch a new series of non-targeted pandemic emergency longer-term refinancing operations (PELTROs). In addition, purchases are conducted under the pandemic emergency purchase programme (PEPP), while net purchases are continuing under the asset purchase programme (APP) at a monthly pace of  20 billion together with the APP purchases under the additional  120 billion temporary envelope available until the end of the year. Together with the substantial monetary policy stimulus already in place, these measures will support liquidity and funding conditions and help to preserve the smooth provision of credit to the real economy. At the same time, the Governing Council will need to continually evaluate the measures, individually and as a package, to assess whether they are still adequately calibrated and of an appropriate size to provide the necessary degree of accommodation in the pursuit of its price stability mandate. The coronavirus outbreak and the associated containment measures have paralysed the global economy and trade. The latest survey data point to a sharp contraction in global activity in the first half of 2020. China recorded its lowest growth level in decades in the first quarter of 2020, while the impact of the pandemic on other key economies is expected to be particularly visible in the second quarter. World trade is also estimated to have fallen sharply, driven by supply chain disruptions and a widespread demand shock. At the same time, the expected rapid deterioration in global activity and trade has been met with forceful policy measures globally. Global ECB Economic Bulletin, Issue 3 / 2020   Update on economic and monetary developments Summary 2 inflationary pressures are expected to decrease further as a result of both the sharp fall in oil prices and weak demand. Since the Governing Council meeting in early March 2020, long-term sovereign yields have increased amid some volatility and the price of risky assets has decreased. The spread of the coronavirus and the lockdown of numerous economies have placed enormous strain on euro area financial markets. However, a number of policy actions have helped to calm markets, leading to a reversal of the negative trend in most asset prices. The EONIA forward curve shifted slightly upwards, as markets were no longer expecting an imminent reduction in the deposit facility rate. In foreign exchange markets, the euro weakened slightly in trade-weighted terms. The latest economic indicators and survey results covering the period since the coronavirus spread to the euro area have shown an unprecedented decline, pointing to a significant contraction in euro area economic activity and to rapidly deteriorating labour markets. The coronavirus pandemic and the associated containment measures have severely affected the manufacturing and services sectors, taking a toll on the productive capacity of the euro area economy and on domestic demand. In the first quarter of 2020, which was only partially affected by the spread of the coronavirus, euro area real GDP decreased by 3.8%, quarter on quarter, reflecting the impact of the lockdown measures in the final weeks of the quarter. The sharp downturn in economic activity in April suggests that the impact is likely to be even more severe in the second quarter. Given the highly uncertain duration of the pandemic, the likely extent and duration of the imminent recession and the subsequent recovery are difficult to predict. 1 Euro area growth is expected to resume as the containment measures are gradually lifted, supported by favourable financing conditions, the euro area fiscal stance and a resumption in global activity. However, the extent of the contraction and the recovery will depend crucially on the duration and the success of the containment measures, how far supply capacity and domestic demand are permanently affected, and the success of policies in mitigating the adverse impact on incomes and employment. According to Eurostat s flash estimate, euro area annual HICP inflation decreased from 0.7% in March to 0.4% in April, largely driven by lower energy price inflation, but also slightly lower HICP inflation excluding energy and food. On the basis of the sharp decline in current and futures prices for oil, headline inflation is likely to decline considerably further over the coming months. The sharp downturn in economic activity is expected to lead to negative effects on underlying inflation over the coming months. However, the medium-term implications of the coronavirus pandemic for inflation are surrounded by high uncertainty, given that downward pressures linked to weaker demand may be partially offset by upward pressures related to supply disruptions. Market-based indicators of longer-term inflation expectations have remained at depressed levels. Even though survey-based indicators of inflation expectations have declined over the short and medium term, longer-term expectations have been less affected. 1 For further information on growth scenarios produced by ECB staff, see the box entitled  Alternative scenarios for the impact of the COVID-19 pandemic on economic activity in the euro area  in this issue of the Economic Bulletin. ECB Economic Bulletin, Issue 3 / 2020   Update on economic and monetary developments Summary 3 Regarding monetary developments, broad money (M3) growth increased to 7.5% in March 2020, from 5.5% in February. M3 growth continues to be backed by bank credit creation for the private sector, and the narrow monetary aggregate M1 remained the main contributor to broad money growth. Developments in loans to the private sector have also been shaped by the impact of the coronavirus. The annual growth rate of loans to households stood at 3.4% in March 2020, after 3.7% in February, while the annual growth rate of loans to non-financial corporations stood at 5.4% in March, after 3.0% in February. The results of the euro area bank lending survey for the first quarter of 2020 also indicate a surge in firms  demand for loans and for drawing on credit lines to meet liquidity needs for working capital, while financing needs for fixed investment have declined. Credit standards for loans to firms tightened slightly, while credit standards for loans to households tightened more strongly. At the same time, banks expect an easing of credit standards for loans to firms in the second quarter of 2020. The Governing Council s policy measures, in particular the more favourable terms for TLTRO III operations and the collateral easing measures, should encourage banks to extend loans to all private sector entities. Combining the outcome of the economic analysis with the signals coming from the monetary analysis, the Governing Council confirmed that an ample degree of monetary accommodation is necessary for the robust convergence of inflation to levels that are below, but close to, 2% over the medium term. On the basis of this assessment, the Governing Council decided to further ease the conditions on the ECB s TLTRO III operations .This will support further the provision of credit to households and firms in the face of the current economic disruption and heightened uncertainty, buffering the coronavirus shock on credit conditions. Specifically, the Governing Council decided to reduce the interest rate on TLTRO III operations during the period from June 2020 to June 2021 to 50 basis points below the average interest rate on the Eurosystem s main refinancing operations prevailing over the sa