European Central Bank — Economic Bulletin (Europe, 2023)

Economic Bulletin Issue 7 / 2023 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 Global production and supply chain risks: insights from a survey of leading companies The inversion of the yield curve and its information content in the euro area and the United States Spillovers to the euro area from recent negative inflation in China Industry structure and the real effects of monetary policy The drivers of recent developments in business activity expectations across sectors Main findings from the ECB s recent contacts with non-financial companies Rent inflation in the euro area Article 1 Statistics Happy anniversary, BLS   20 years of the euro area bank lending survey 2 2 6 10 16 21 24 33 33 42 47 52 55 60 65 73 73 S1 ECB Economic Bulletin, Issue 7 / 2023   Contents 1 Update on economic, financial and monetary developments Summary The Governing Council decided at its meeting on 26 October 2023 to keep the three key ECB interest rates unchanged. The incoming information has broadly confirmed its previous assessment of the medium-term inflation outlook. Inflation is still expected to stay too high for too long, and domestic price pressures remain strong. At the same time, inflation dropped markedly in September, including due to strong base effects, and most measures of underlying inflation have continued to ease. The Governing Council s past interest rate increases continue to be transmitted forcefully into financing conditions. This is increasingly dampening demand and thereby helps push down inflation. The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal. The Governing Council s future decisions will ensure that its policy rates will be set at sufficiently restrictive 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 Governing Council s interest rate decisions will be based on its 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. Economic activity The euro area economy remains weak. Recent information suggests that manufacturing output has continued to fall. Subdued foreign demand and tighter financing conditions are increasingly weighing on investment and consumer spending. The services sector is also weakening further. This is mainly because weaker industrial activity is spilling over to other sectors, the impetus from reopening effects is fading and the impact of higher interest rates is broadening. The economy is likely to remain weak for the remainder of 2023. But as inflation falls further, household real incomes recover and the demand for euro area exports picks up, the economy should strengthen over the coming years. Economic activity has so far been supported by the strength of the labour market. The unemployment rate stood at a historical low of 6.4% in August. At the same time, there are signs that the labour market is weakening. Fewer new jobs are being ECB Economic Bulletin, Issue 7 / 2023   Update on economic, financial and monetary developments Summary 2 created, including in services, consistent with the cooling economy gradually feeding through to employment. As the energy crisis fades, governments should continue to roll back the related support measures. This is essential to avoid driving up medium-term inflationary pressures, which would otherwise call for even tighter monetary policy. Fiscal policies should be designed to make the euro area economy more productive and to gradually bring down high public debt. Structural reforms and investments to enhance the euro area s supply capacity   which would be supported by the full implementation of the Next Generation EU programme   can help reduce price pressures in the medium term, while supporting the green and digital transitions. To that end, the reform of the EU s economic governance framework should be concluded before the end of this year and progress towards a capital markets union and the completion of the banking union should be accelerated. Inflation Inflation dropped to 4.3% in September, almost a full percentage point lower than its August level. In the near term, it is likely to come down further, as the sharp price increases in energy and food recorded in autumn 2022 will drop out of the yearly rates. September s decline was broad-based. Food price inflation slowed again, although it remains high by historical standards. In annual terms, energy prices fell by 4.6% but, most recently, have risen again and become less predictable in view of the new geopolitical tensions. Inflation excluding energy and food dropped to 4.5% in September, from 5.3% in August. This fall was supported by improving supply conditions, the pass-through of previous declines in energy prices, and the impact of tighter monetary policy on demand and corporate pricing power. Goods and services inflation rates fell substantially, to 4.1% and 4.7% respectively, with services inflation also being pulled down by pronounced base effects. Price pressures in tourism and travel appear to be moderating. Most measures of underlying inflation continue to decline. At the same time, domestic price pressures are still strong, reflecting also the growing importance of rising wages. Measures of longer-term inflation expectations mostly stand around 2%. Nonetheless, some indicators remain elevated and need to be monitored closely. Risk assessment The risks to economic growth remain tilted to the downside. Growth could be lower if the effects of monetary policy turn out stronger than expected. A weaker world economy would also weigh on growth. Russia s unjustified war against Ukraine and the tragic conflict triggered by the terrorist attacks in Israel are key sources of geopolitical risk. This may result in firms and households becoming less confident ECB Economic Bulletin, Issue 7 / 2023   Update on economic, financial and monetary developments Summary 3 and more uncertain about the future, and dampen growth further. Conversely, growth could be higher than expected if the still resilient labour market and rising real incomes mean that people and businesses become more confident and spend more, or the world economy grows more strongly than expected. Upside risks to inflation could come from higher energy and food costs. The heightened geopolitical tensions could drive up energy prices in the near term, while making the medium-term outlook more uncertain. Extreme weather, and the unfolding climate crisis more broadly, could push food prices up by more than expected. 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. By contrast, weaker demand   for example owing to a stronger transmission of monetary policy or a worsening of the economic environment in the rest of the world amid greater geopolitical risks   would ease price pressures, especially over the medium term. Financial and monetary conditions Longer-term interest rates have risen markedly since the September 2023 meeting, reflecting strong increases in other major economies. The Governing Council s monetary policy continues to transmit strongly into broader financing conditions. Funding has become more expensive for banks, and interest rates for business loans and mortgages rose again in August, to 5.0% and 3.9% respectively. Higher borrowing rates, with the associated cuts in investment plans and house purchases, led to a further sharp drop in credit demand in the third quarter, as reported in the October 2023 bank lending survey. Moreover, credit standards for loans to firms and households tightened further. Banks are becoming more concerned about the risks faced by their customers and are less willing to take on risks themselves. Against this background, credit dynamics have weakened further. The annual growth rate of loans to firms has dropped sharply, from 2.2% in July to 0.7% in August and 0.2% in September. Loans to households remained subdued, with the growth rate slowing to 1.0% in August and 0.8% in September. Amid weak lending and the reduction in the Eurosystem balance sheet, the annual growth rate of M3 fell to -1.3% in August   the lowest level recorded since the start of the euro   and still stood at -1.2% in September. Monetary policy decisions The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility were unchanged at 4.50%, 4.75% and 4.00% respectively. ECB Economic Bulletin, Issue 7 / 2023   Update on economic, financial and monetary developments Summary 4 The asset purchase programme (APP) portfolio is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities. As concerns the pandemic emergency purchase programme (PEPP), the Governing Council intends to reinvest the principal payments from maturing securities purchased under the programme until at least the end of 2024. In any case, the future roll-off of th