European Central Bank — Economic Bulletin (Europe, 2020)

Economic Bulletin Issue 2 / 2020 Contents Economic and monetary developments Overview Addendum on the decisions taken by the Governing Council on 18 March 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 Articles 1 2 3 Statistics Using information in newspaper articles as an indicator of real economic activity The role of multinational taxation in the first reversal of foreign direct investment flows in the euro area Liquidity conditions and monetary policy operations in the period from 30 October 2019 to 28 January 2020 The implications of fiscal measures to address climate change Multinational enterprises, financial centres and their implications for external imbalances: a euro area perspective Short-term forecasting of euro area economic activity at the ECB The state of play regarding the deepening agenda for Economic and Monetary Union 2 2 7 9 17 23 28 33 41 44 44 47 51 57 60 60 84 96 S1 ECB Economic Bulletin, Issue 2 / 2020   Contents 1 Economic and monetary developments Overview At its monetary policy meeting on 12 March, the Governing Council decided on a comprehensive package of monetary policy measures. Together with the substantial monetary policy stimulus already in place, these measures will support liquidity and funding conditions for households, businesses and banks and will help to preserve the smooth provision of credit to the real economy. Since the last Governing Council meeting in late January, the spread of the coronavirus (COVID-19) has been a major shock to the growth prospects of the global and euro area economies and has heightened market volatility. Even if ultimately temporary in nature, it will have a significant impact on economic activity. In particular, it will slow down production as a result of disrupted supply chains and reduce domestic and foreign demand, especially through the adverse impact of the necessary containment measures. In addition, the heightened uncertainty negatively affects expenditure plans and their financing. The risks surrounding the euro area growth outlook are clearly on the downside. In addition to the previously identified risks related to geopolitical factors, rising protectionism and vulnerabilities in emerging markets, the spread of the coronavirus adds a new and substantial source of downside risk to the growth outlook. Against this background, the ECB s Governing Council took a number of policy decisions to preserve the monetary stance and to underpin the transmission of monetary policy to the real economy. Economic and monetary assessment at the time of the Governing Council meeting of 12 March 2020 The unfolding COVID-19 epidemic is worsening the outlook for the global economy as embedded in the March 2020 ECB staff macroeconomic projections. Developments since the cut-off date for the projections suggest that the downside risk to global activity related to the COVID-19 outbreak has partly materialised, implying that global activity this year will be weaker than envisaged in the projections. The outbreak hit the global economy as signs of a stabilisation in activity and trade had started to emerge and the signing of the so-called Phase 1 trade agreement between the United States and China, accompanied by cuts in tariffs, had reduced uncertainty. Looking further ahead, the projected global recovery is expected to gain only modest traction. It will hinge on the recovery in a number of still vulnerable emerging market economies, while the projected cyclical slowdown in advanced economies and the structural transition to a slower growth trajectory in China will weigh on the medium-term outlook. The risks to global activity have changed, but their balance remains tilted to the downside. At the moment, the most acute downside risk relates to the potentially broader and longer impact of the COVID-19 outbreak as it continues to evolve. Global inflationary pressures remain contained. Global risk sentiment deteriorated sharply and market volatility surged as the coronavirus spread around the world towards the end of the review period (12 ECB Economic Bulletin, Issue 2 / 2020   Economic and monetary developments Overview 2 December 2019 to 11 March 2020). Euro area long-term risk-free rates declined markedly to levels significantly lower than at the start of the period. The forward curve of the euro overnight index average (EONIA) shifted sharply downwards; its inversion at shorter to medium-term maturities signalled market pricing of further monetary policy accommodation. In line with the sharp rise in global risk aversion, euro area equity prices decreased strongly, while sovereign and corporate bond spreads widened. In volatile foreign exchange markets, the euro appreciated substantially against the currencies of 38 of the euro area s most important trading partners. Euro area real GDP growth remained subdued at 0.1%, quarter on quarter, in the fourth quarter of 2019, following growth of 0.3% in the previous quarter, driven by ongoing weakness in the manufacturing sector and slowing investment growth. Incoming economic data and survey information point to euro area growth dynamics at low levels, not yet fully reflecting developments related to the coronavirus, which started to spread across continental Europe at the end of February, adversely affecting economic activity. Looking beyond the disruptions stemming from the spreading of the coronavirus, euro area growth is expected to regain traction over the medium term, supported by favourable financing conditions, the euro area fiscal stance and the expected resumption in global activity. According to the March 2020 ECB staff macroeconomic projections for the euro area, annual real GDP is expected to increase by 0.8% in 2020, 1.3% in 2021 and 1.4% in 2022. Compared with the December 2019 Eurosystem staff macroeconomic projections, the outlook for real GDP growth has been revised down by 0.3 percentage points for 2020 and by 0.1 percentage points for 2021, mainly on account of the coronavirus outbreak, although the recent rapid spread of the virus in the euro area is only partly reflected. The risks surrounding the euro area growth outlook are therefore clearly on the downside. The spread of the coronavirus adds a new and substantial source of downside risk to the growth outlook, in addition to risks related to geopolitical factors, rising protectionism and vulnerabilities in emerging markets. According to Eurostat s flash estimate, euro area annual HICP inflation decreased to 1.2% in February 2020, from 1.4% in January. On the basis of the sharp decline in current and futures prices for oil, headline inflation is likely to decline considerably over the coming months. This assessment is only partly reflected in the March 2020 ECB staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.1% in 2020, 1.4% in 2021 and 1.6% in 2022, and are broadly unrevised compared to the December 2019 Eurosystem staff projections. Over the medium term, inflation will be supported by the ECB s monetary policy measures. The implications of the coronavirus for inflation are surrounded by high uncertainty, given that downward pressures linked to weaker demand may be offset by upward pressures related to supply disruptions. The recent sharp decline in oil prices poses significant downside risks to the short-term inflation outlook. Monetary dynamics have moderated from comfortable levels since late summer 2019. Credit to the private sector has continued to display divergent developments across loan categories. While lending to households has remained resilient, lending to firms has moderated. Favourable bank funding and lending conditions have continued to support lending and thereby economic growth. Euro area ECB Economic Bulletin, Issue 2 / 2020   Economic and monetary developments Overview 3 firms  total net external financing has stabilised, supported by favourable debt financing costs. However, the recent increase in risk-off sentiment is likely to cause non-bank financing conditions for non-financial corporations to deteriorate. The euro area general government budget balance is projected to decline in 2020 and 2021 and to stabilise in 2022. The decline can be largely attributed to lower primary surpluses. These developments are also reflected in the projections in an expansionary fiscal stance in both 2020 and 2021, followed by a broadly neutral stance in 2022. Despite the relatively expansionary fiscal stance, in the projections the euro area government debt-to-GDP ratio is expected to remain on a gradual downward path, owing to a favourable interest rate-growth differential and a somewhat positive primary balance for the entire period. Developments related to the spread of the coronavirus (COVID-19) after the projections were finalised point to a clear worsening of the outlook for the fiscal stance. In addition to previously announced fiscal policies, the Eurogroup s commitment to joint and coordinated policy action should be strongly supported in the light of the spread of the virus. The monetary policy package On 12 March 2020 the Governing Council decided on a comprehensive package of monetary policy measures. The monetary policy response encompassed three key elements: first, safeguarding liquidity conditions in the banking system through a series of favourably-priced longer-term refinancing operations (LTROs); second, protecting the continued flow of credit to the real economy through a fundamental recalibration of targeted longer-term refinancing operations (TLTROs); and, third, preventing financing conditions for the economy tig