European Central Bank — Economic Bulletin (Europe, 2022)

Economic Bulletin Issue 8 / 2022 Contents Economic, financial and monetary developments Overview 1 2 3 4 5 6 External environment Economic activity Prices and costs Financial market developments Financing conditions and credit developments Fiscal developments Boxes 1 2 3 4 5 6 7 8 Inflation developments in the euro area and the United States Croatia adopts the euro The impact of higher energy prices on services and goods consumption in the euro area Wage dynamics across euro area countries since the start of the pandemic Firms  access to finance and the business cycle: evidence from the SAFE Liquidity conditions and monetary policy operations from 27 July to 1 November 2022 What information does the euro area bank lending survey provide on future loan developments? Fiscal policy implications of euro area countries  2023 draft budgetary plans Articles 1 2 The pandemic emergency purchase programme   an initial review Wage developments and their determinants since the start of the pandemic Statistics ECB Economic Bulletin, Issue 8 / 2022   Contents 2 2 8 15 22 30 35 43 47 47 54 60 64 69 75 81 89 93 93 117 S1 1 Economic, financial and monetary developments Overview On 15 December 2022 the Governing Council decided to raise the three key ECB interest rates by 50 basis points and, based on the substantial upward revision to the inflation outlook, expects to raise them further. In particular, the Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target. Keeping interest rates at restrictive levels will over time reduce inflation by dampening demand and will also guard against the risk of a persistent upward shift in inflation expectations. The Governing Council s future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach. The key ECB interest rates are the Governing Council s primary tool for setting the monetary policy stance. At its December meeting, the Governing Council also discussed principles for normalising the Eurosystem s monetary policy securities holdings. From the beginning of March 2023 onwards, the asset purchase programme (APP) portfolio will decline at a measured and predictable pace, as the Eurosystem will not reinvest all of the principal payments from maturing securities. The decline will amount to  15 billion per month on average until the end of the second quarter of 2023 and its subsequent pace will be determined over time. At its meeting in February 2023 the Governing Council will announce the detailed parameters for reducing the APP holdings. The Governing Council will regularly reassess the pace of the APP portfolio reduction to ensure it remains consistent with the overall monetary policy strategy and stance, to preserve market functioning, and to maintain firm control over short-term money market conditions. By the end of 2023, the Governing Council will also review its operational framework for steering short-term interest rates, which will provide information regarding the endpoint of the balance sheet normalisation process. At its December 2022 meeting, the Governing Council decided to raise interest rates, and expects to raise them significantly further, because inflation remains far too high and is projected to stay above the target for too long. According to Eurostat s flash estimate, inflation was 10.0% in November, slightly lower than the 10.6% recorded in October. The decline resulted mainly from lower energy price inflation. Food price inflation and underlying price pressures across the economy have strengthened and will persist for some time. Amid exceptional uncertainty, Eurosystem staff have significantly revised up their inflation projections. They now see average inflation reaching 8.4% in 2022 before decreasing to 6.3% in 2023, with inflation expected to decline markedly over the course of the year. Inflation is then projected to average 3.4% in 2024 and 2.3% in 2025. Inflation excluding energy and food is projected to ECB Economic Bulletin, Issue 8 / 2022   Economic, financial and monetary developments Overview 2 be 3.9% on average in 2022 and to rise to 4.2% in 2023, before falling to 2.8% in 2024 and 2.4% in 2025. The euro area economy may contract in the fourth quarter of 2022 and the first quarter of 2023, owing to the energy crisis, high uncertainty, weakening global economic activity and tighter financing conditions. According to the December 2022 Eurosystem staff macroeconomic projections for the euro area, a recession would be relatively short-lived and shallow. Growth is nonetheless expected to be subdued in 2023 and has been revised down significantly compared with the September 2022 ECB staff projections for the euro area. Beyond the near term, growth is projected to recover as the current headwinds fade. Overall, the December 2022 projections now see the economy growing by 3.4% in 2022, 0.5% in 2023, 1.9% in 2024 and 1.8% in 2025. Economic activity The global economic outlook has deteriorated in the face of elevated geopolitical uncertainty, high and rising inflation and tight financial conditions. According to the December 2022 projections, the global real GDP growth rate (excluding the euro area) is projected to slow to 2.6% in 2023, below its long-term average, before gradually recovering to 3.1% and 3.3% in 2024 and 2025 respectively. This outlook is weaker than that described in the September 2022 projections. The outlook for global trade and euro area foreign demand has also deteriorated compared with the September 2022 projections. Global price pressures remain broad-based and elevated amid still relatively robust demand, tight labour markets and high food prices, but are expected to decline as commodity markets stabilise and growth weakens. In an environment of high uncertainty, the balance of risks around the baseline projections is tilted to the downside for global growth and to the upside for global price pressures. Economic growth in the euro area slowed to 0.3% in the third quarter of the year. High inflation and tighter financing conditions are dampening spending and production by reducing real household incomes and pushing up costs for firms. The world economy is also slowing, in a context of continued geopolitical uncertainty, especially owing to Russia s unjustified war against Ukraine and its people, and tighter financing conditions worldwide. The past deterioration in the terms of trade, reflecting the faster rise in import prices than in export prices, continues to weigh on purchasing power in the euro area. On the positive side, employment increased by 0.3% in the third quarter, and unemployment hit a new historical low of 6.5% in October. Rising wages are set to restore some lost purchasing power, supporting consumption. As the economy weakens, however, job creation is likely to slow, and unemployment could rise over the coming quarters. The outlook for the euro area has deteriorated somewhat, with weaker growth and higher and more persistent inflation than envisaged in the September 2022 projections. Staff now expects a short-lived and shallow recession in the euro area at ECB Economic Bulletin, Issue 8 / 2022   Economic, financial and monetary developments Overview 3 the turn of the year. As the economic consequences of the war in Ukraine unfold and fuel the strong inflationary pressures, consumer and business confidence have remained subdued, while real disposable incomes are being eroded and soaring cost pressures are curtailing production, especially in energy-intensive industries. The negative economic repercussions are expected to be partially mitigated by fiscal policy measures. In addition, high levels of natural gas inventories and ongoing efforts to reduce demand and replace Russian gas with alternative sources imply that the euro area is expected to avoid the need for mandated energy-related production cuts over the projection horizon, although risks of energy supply disruptions remain elevated, in particular for the winter of 2023-24. Over the medium term, as the energy market rebalances, it is expected that uncertainty will decline, and real incomes will improve. As a result, economic growth is expected to rebound, also supported by strengthening foreign demand and the resolution of remaining supply bottlenecks, despite less favourable financing conditions. The labour market is expected to remain relatively resilient to the coming mild recession, reflecting labour hoarding amid still significant labour shortages. Overall, annual average real GDP growth is expected to slow down markedly, from 3.4% in 2022 to 0.5% in 2023, and then to rebound to 1.9% in 2024 and 1.8% in 2025. Compared with the September 2022 projections, the outlook for GDP growth has been revised up by 0.3 percentage points for 2022, owing to positive surprises over the summer, and revised down by 0.4 percentage points for 2023, while it is unchanged for 2024. According to the December 2022 projections, the euro area budget balance is projected to worsen in 2023 before improving thereafter, while government debt is projected to decline over the full projection horizon. After an estimated improvement for 2022 (from -5.1% of GDP in 2021 to -3.5% in 2022), the budget balance is projected to decline to -3.7% in 2023. Further improvements are expected in 2024 and, to a lesser extent, in 2025, when the budget balance is projected to be -2.6% of GDP. Nonetheless, this is still well below the pre-pandemic level (-0.6%). After the sharp increase in 2020, euro area aggregate government de