European Central Bank — Economic Bulletin (Europe, 2022)

Economic Bulletin Issue 5 / 2022 Contents Update on economic, financial and monetary developments Summary 1 2 3 4 5 External environment Economic activity Prices and costs Financial market developments Financing conditions and credit developments Boxes 1 2 3 4 5 6 7 Trade flows with Russia since the start of its invasion of Ukraine Wage share dynamics and second-round effects on inflation after energy price surges in the 1970s and today Household saving during the COVID-19 pandemic and implications for the recovery of consumption How higher oil prices could affect euro area potential output Main findings from the ECB s recent contacts with non-financial companies Selling price expectations among euro area enterprises Euro area fiscal policy response to the war in Ukraine and its macroeconomic impact Articles 1 2 The recovery in business investment   drivers, opportunities, challenges and risks Guaranteeing freedom of payment choice: access to cash in the euro area Statistics 2 2 7 11 18 23 26 33 33 40 47 52 57 60 65 72 72 91 S1 ECB Economic Bulletin, Issue 5 / 2022   Contents 1 Update on economic, financial and monetary developments Summary At its meeting on 21 July 2022, in line with its strong commitment to its price stability mandate, the Governing Council took further key steps to make sure inflation returns to its 2% target over the medium term. The Governing Council decided to raise the three key ECB interest rates by 50 basis points and approved the Transmission Protection Instrument (TPI). The Governing Council judged that it was appropriate to take a larger first step on its policy rate normalisation path than signalled at its previous meeting. This decision was based on the Governing Council s updated assessment of inflation risks and the reinforced support provided by the TPI for the effective transmission of monetary policy. It will support the return of inflation to the Governing Council s medium-term target by strengthening the anchoring of inflation expectations and by ensuring that demand conditions adjust to deliver its inflation target in the medium term. At the Governing Council s upcoming meetings, further normalisation of interest rates will be appropriate. The frontloading of the exit from negative interest rates to the July meeting allows the Governing Council to make a transition to a meeting-by- meeting approach to interest rate decisions. The Governing Council s future policy rate path will continue to be data-dependent and will help to deliver on its 2% inflation target over the medium term. In the context of its policy normalisation, the Governing Council will evaluate options for remunerating excess liquidity holdings. The Governing Council assessed that the establishment of the TPI was necessary to support the effective transmission of monetary policy. In particular, as the Governing Council continues normalising monetary policy, the TPI will ensure that the monetary policy stance is transmitted smoothly across all euro area countries. The singleness of the Governing Council s monetary policy is a precondition for the ECB to be able to deliver on its price stability mandate. The TPI will be an addition to the Governing Council s toolkit and can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area. The scale of TPI purchases would depend on the severity of the risks facing policy transmission. Purchases are not restricted ex ante. By safeguarding the transmission mechanism, the TPI will allow the Governing Council to more effectively deliver on its price stability mandate. In any event, the flexibility in reinvestments of redemptions coming due in the pandemic emergency purchase programme (PEPP) portfolio remains the first line of defence to counter risks to the transmission mechanism related to the pandemic. ECB Economic Bulletin, Issue 5 / 2022   Update on economic, financial and monetary developments Summary 2 Economic activity Economic activity has decelerated in key advanced economies since the last Governing Council meeting in June. In the United States, consumer spending in May surprised significantly to the downside, while there continue to be solid employment gains. Downside risks to the US outlook have increased overall. Activity data for the United Kingdom surprised to the downside, and consumer confidence fell to a record low. Growth in China is recovering after the country emerged from the most recent wave of the pandemic, but remains weak. Meanwhile, inflation in key advanced economies continues to rise, with elevated month-on-month gains, and is increasingly spreading to the service sector. Since the June Governing Council meeting, oil prices have fallen by around 14% as higher risks of an economic slowdown outweigh supply disruptions. Gas prices have increased sharply in Europe owing to reduced supply from Russia, implying an aggravation of the energy shock despite the fall in oil prices. Euro area economic activity is slowing. Russia s unjustified aggression towards Ukraine is an ongoing drag on growth. The impact of high inflation on purchasing power, continuous supply constraints and higher uncertainty are having a dampening effect on the economy. Firms continue to face higher costs and disruptions in their supply chains, although there are tentative signs that some of the supply bottlenecks are easing. Taken together, these factors are significantly clouding the outlook for the second half of 2022 and beyond. At the same time, economic activity continues to benefit from the reopening of the economy, a strong labour market and fiscal policy support. In particular, the full reopening of the economy is supporting spending in the services sector. As people start to travel again, tourism is expected to help the economy in the third quarter of this year. Consumption is being supported by the savings that households built up during the pandemic and by a strong labour market. Fiscal policy is helping to cushion the impact of the war in Ukraine for those bearing the brunt of higher energy prices. Temporary and targeted measures should be tailored so as to limit the risk of fuelling inflationary pressures. Fiscal policies in all countries should aim at preserving debt sustainability, as well as raising the growth potential in a sustainable manner to enhance the recovery. Inflation Inflation increased further to 8.6% in June. Surging energy prices were again the most important component of overall inflation. Market-based indicators suggest that global energy prices will stay high in the near term. Food inflation also rose further, standing at 8.9% in June, in part reflecting the importance of Ukraine and Russia as producers of agricultural goods. Persistent supply bottlenecks for industrial goods and recovering demand, especially in the services sector, are also contributing to the current high rates of inflation. Price pressures are spreading across more and more sectors, in part owing to the indirect ECB Economic Bulletin, Issue 5 / 2022   Update on economic, financial and monetary developments Summary 3 impact of high energy costs across the whole economy. Accordingly, most measures of underlying inflation have risen further. The Governing Council expects inflation to remain undesirably high for some time, owing to continued pressures from energy and food prices and pipeline pressures in the pricing chain. Higher inflationary pressures are also stemming from the depreciation of the euro exchange rate. But looking further ahead, in the absence of new disruptions, energy costs should stabilise and supply bottlenecks should ease, which, together with the ongoing policy normalisation, should support the return of inflation to the Governing Council s target. The labour market remains strong. Unemployment fell to a historical low of 6.6% in May. Job vacancies across many sectors show that there is robust demand for labour. Wage growth, also according to forward-looking indicators, has continued to increase gradually over the last few months, but still remains contained overall. Over time, the strengthening of the economy and some catch-up effects should support faster growth in wages. Most measures of longer-term inflation expectations currently stand at around 2%, although recent above-target revisions to some indicators warrant continued monitoring. Risk assessment A prolongation of the war in Ukraine remains a source of significant downside risk to growth, especially if energy supplies from Russia were to be disrupted to such an extent that it led to rationing for firms and households. The war may also further dampen confidence and aggravate supply-side constraints, while energy and food costs could remain persistently higher than expected. A faster deceleration in global growth would also pose a risk to the euro area outlook. The risks to the inflation outlook continue to be on the upside and have intensified, particularly in the short term. The risks to the medium-term inflation outlook include a durable worsening of the production capacity of the economy, persistently high energy and food prices, inflation expectations rising above the Governing Council s target and higher than anticipated wage rises. However, if demand were to weaken over the medium term, it would lower pressures on prices. Financial and monetary conditions Market interest rates have been volatile as a result of the pronounced economic and geopolitical uncertainty. Bank funding costs have risen in recent months, which has increasingly fed into higher bank lending rates, in particular for households. While the volume of bank lending to