European Central Bank — Economic Bulletin (Europe, 2016)

Economic Bulletin Issue 5 / 2016 Contents Update of 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 5 Recent developments in capital flows to emerging market economies The corporate bond market and the ECB s corporate sector purchase programme The launch of money market statistical reporting Recent developments in euro area construction activity Trends in the external financing structure of euro area non-financial corporations 6 The 2016 country-specific recommendations Articles 1 2 3 The layers of the global financial safety net: taking stock New evidence on wage adjustment in Europe during the period 2010-13 Increasing resilience and long-term growth: the importance of sound institutions and economic structures for euro area countries and EMU Statistics ECB Economic Bulletin, Issue 5 / 2016 2 2 4 6 8 10 12 16 20 24 26 29 33 36 53 76 S1 1 Update of economic and monetary developments Summary Financial market volatility following the referendum in the United Kingdom on EU membership has been short-lived. However, uncertainty about the global outlook has increased, while incoming data for the second quarter point to subdued global activity and trade. Global headline inflation, meanwhile, has remained at low levels, mainly reflecting past energy price declines. Risks to the outlook for global activity, and in particular for emerging market economies, remain on the downside and relate primarily to political uncertainty and financial volatility. Euro area financial markets have weathered the spike in uncertainty and volatility following the UK referendum with encouraging resilience. As a result, overall financial conditions remain highly supportive. In particular, while the EONIA forward curve has shifted downwards, especially at longer horizons, possibly reflecting expectations of both lower growth and further monetary policy actions, followed by low-risk sovereign bond yields, sovereign spreads vis- -vis ten-year German government bonds have narrowed and those on corporate bonds have continued to tighten. At the same time, euro area banks  equity prices have declined further. The economic recovery in the euro area is continuing, supported by domestic demand, while export growth remains modest. Looking ahead, the economic recovery is expected to proceed at a moderate pace. Domestic demand remains supported by the pass-through of the ECB s monetary policy measures to the real economy. Favourable financing conditions and improvements in corporate profitability continue to promote a recovery in investment. Sustained employment gains, which are also benefiting from past structural reforms, and still relatively low oil prices provide additional support for households  real disposable income and thus for private consumption. In addition, the fiscal stance in the euro area is expected to be mildly expansionary in 2016 and to turn broadly neutral in 2017 and 2018. At the same time, headwinds to the economic recovery in the euro area include the outcome of the UK referendum and other geopolitical uncertainties, subdued growth prospects in emerging markets, the necessary balance sheet adjustments in a number of sectors and a sluggish pace of implementation of structural reforms. Against this background, the risks to the euro area growth outlook remain tilted to the downside. Euro area headline inflation has remained at levels around zero in recent months. Measures of underlying inflation have on balance not yet shown clear signs of an upward trend, while pipeline price pressures have remained subdued. Market-based measures of long-term inflation expectations have declined further and remain substantially below survey-based measures of expectations. Looking ahead, on the basis of current futures prices for oil, inflation rates are likely to remain very low in ECB Economic Bulletin, Issue 5 / 2016 2 the next few months before starting to pick up later in 2016, in large part owing to base effects in the annual rate of change of energy prices. Supported by the ECB s monetary policy measures and the expected economic recovery, inflation rates should increase further in 2017 and 2018. The monetary policy measures in place since June 2014, including the comprehensive package of new monetary policy measures adopted in March this year, have significantly improved borrowing conditions for firms and households, as well as credit flows across the euro area, thereby supporting the economic recovery. In particular, low interest rates, as well as the effects of the ECB s targeted longer- term refinancing operations and the expanded asset purchase programme, continue to support robust growth in money and the gradual recovery in credit dynamics. Banks have been passing on their favourable funding conditions in the form of lower lending rates, and improved lending conditions are fostering a recovery in loan growth. Indeed, the euro area bank lending survey for the second quarter of 2016 indicated further improvements in loan supply conditions for loans to enterprises and households and a continued increase in loan demand across all loan categories. In the light of the prevailing uncertainties, it is essential that the bank lending channel continues to function well. At its meeting on 21 July 2016, based on the regular economic and monetary analyses, the Governing Council decided to keep the key ECB interest rates unchanged. The Governing Council continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases. Regarding non-standard monetary policy measures, the Governing Council confirmed that the monthly asset purchases of  80 billion are intended to run until the end of March 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. Given prevailing uncertainties, the Governing Council will continue to monitor economic and financial market developments very closely and to safeguard the pass-through of its accommodative monetary policy to the real economy. Over the coming months, as more information becomes available, including new staff projections, the Governing Council will be in a better position to reassess the underlying macroeconomic conditions, the most likely paths of inflation and growth, and the distribution of risks around those paths. If warranted to achieve its objective, the Governing Council will act by using all the instruments available within its mandate. The Governing Council confirmed the need to preserve an appropriate degree of monetary accommodation in order to secure a return of inflation rates towards levels that are below, but close to, 2% without undue delay. ECB Economic Bulletin, Issue 5 / 2016 3 1 External environment The vote in the United Kingdom in favour of leaving the European Union triggered some financial market volatility and increased uncertainty about the global outlook. The outcome of the referendum took financial markets by surprise and prices adjusted rapidly in the immediate aftermath of the vote. Since 23 June the pound sterling has depreciated sharply. However, the impact on most global markets has been short-lived, although bank equities have declined, particularly in the euro area. Uncertainty about the global outlook has risen since the referendum. In the short-term the largest impact has been felt by the UK economy, as uncertainty about the future trading and investment relationships between the United Kingdom and the EU is weighing on demand. Other non-euro area European economies, particularly those with close trading links with the United Kingdom, may also be affected. Outside Europe, the impact is expected to be more limited but political uncertainty across advanced economies has risen, which could dampen confidence and investment. Private sector forecasts for major economies have been revised downwards slightly. Amid heightened uncertainty, financial markets expect a more accommodative monetary policy stance in major advanced economies. The Bank of England left interest rates unchanged at its meeting in July, although it signalled possible action in the near future. In the United States, market expectations for interest rate increases during 2016 have moderated. According to the federal funds futures curve, markets are fully pricing in a 25 basis point hike only towards the end of 2017. Financial markets also expect further easing by the Bank of Japan. Chart 1 The global composite output PMI (diffusion index: 50 = no change) global excluding euro area (right-hand scale) global excluding euro area   long-term average (right-hand scale) advanced economies excluding euro area (left-hand scale) emerging market economies (left-hand scale) 60 55 50 45 2010 2011 2012 2013 2014 2015 2016 Sources: Markit and ECB staff calculations. Note: The latest observation is for June 2016. Global indicators for the second quarter of 2016 point to subdued economic activity and trade. The global composite output Purchasing Managers  Index (PMI) recorded a further decline in the second quarter, falling to 51.3   the lowest value seen since end-2012 (see Chart 1). Global trade growth has contracted further. The volume of world imports of goods fell by 0.6% in April 2016, on a three-month-on-three-month basis. While trade growth improved in advanced economies, it deteriorated further in emerging market economies (EMEs), particularly Asia. The short-term outlook for global trade is subdued, with the glo