European Central Bank — Economic Bulletin (Europe, 2023)

Economic Bulletin Issue 1 / 2023 Contents 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 risks to the EU natural gas market How have higher energy prices affected industrial production and imports? Main findings from the ECB s recent contacts with non-financial companies How people want to work   preferences for remote work after the pandemic Climate-related policies in the Eurosystem/ECB staff macroeconomic projections for the euro area and the macroeconomic impact of green fiscal measures An updated assessment of short-term inflation projections by Eurosystem and ECB staff Substitution between debt security issuance and bank loans: evidence from the SAFE Statistics 1 2 2 8 13 20 25 28 35 35 40 47 50 56 61 66 S1 Economic Bulletin, Issue 1/2023   Contents 1 Update on economic, financial and monetary developments Summary The Governing Council will stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive to ensure a timely return of inflation to its 2% medium-term target. Accordingly, at its meeting on 2 February 2023, the Governing Council decided to raise the three key ECB interest rates by 50 basis points and it expects to raise them further. In view of the underlying inflation pressures, the Governing Council intends to raise interest rates by another 50 basis points at its next monetary policy meeting in March and it will then evaluate the subsequent path of its monetary policy. 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. In any event, the Governing Council s future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach. At its meeting on 2 February 2023, the Governing Council also decided on the modalities for reducing the Eurosystem s holdings of securities under the asset purchase programme (APP). As communicated in December, the APP portfolio will decline by  15 billion per month on average from the beginning of March until the end of June 2023, and the subsequent pace of portfolio reduction will be determined over time. Partial reinvestments will be conducted broadly in line with current practice. In particular, the remaining reinvestment amounts will be allocated proportionally to the share of redemptions across each constituent programme of the APP and, under the public sector purchase programme (PSPP), to the share of redemptions of each jurisdiction and across national and supranational issuers. For the Eurosystem s corporate bond purchases, the remaining reinvestments will be tilted more strongly towards issuers with a better climate performance. Without prejudice to the ECB s price stability objective, this approach will support the gradual decarbonisation of the Eurosystem s corporate bond holdings, in line with the goals of the Paris Agreement. Economic activity Survey data point to weakening global economic activity at the turn of the year, following robust growth in the third quarter of 2022. The abrupt reversal of the zero-COVID policy in China is likely to weigh on Chinese activity in the near term. At a global level, persistent inflationary pressures are eroding disposable income. Bottlenecks in global supply chains have continued to normalise, but disruptions to economic activity in China could trigger renewed supply chain bottlenecks, with global repercussions. Global trade momentum continued to moderate in November, while early indicators and nowcasts point to a contraction in the fourth quarter of 2022. Price Economic Bulletin, Issue 1/2023   Update on economic, financial and monetary developments Summary 2 pressures at the global level remain high but may have peaked, as headline inflation for the OECD as a whole moderated further in November. According to Eurostat s preliminary flash estimate, the euro area economy grew by 0.1% in the fourth quarter of 2022. While above the December 2022 Eurosystem staff projections, this outcome means that economic activity has slowed markedly since mid-2022 and the Governing Council expects it to stay weak in the near term. Subdued global activity and high geopolitical uncertainty, especially owing to Russia s unjustified war against Ukraine and its people, continue to act as headwinds to euro area growth. Together with high inflation and tighter financing conditions, these headwinds dampen spending and production, especially in the manufacturing sector. However, supply bottlenecks are gradually easing, the supply of gas has become more secure, firms are still working off large order backlogs and confidence is improving. Moreover, output in the services sector has been holding up, supported by continuing reopening effects and stronger demand for leisure activities. Rising wages and the recent decline in energy price inflation are also set to ease the loss of purchasing power that many people have experienced owing to high inflation. This, in turn, will support consumption. Overall, the economy has proved more resilient than expected and should recover over the coming quarters. The unemployment rate remained at its historical low of 6.6% in December 2022. However, the rate at which jobs are being created may slow and unemployment could rise over the coming quarters. Government support measures to shield the economy from the impact of high energy prices should be temporary, targeted and tailored to preserving incentives to consume less energy. In particular, as the energy crisis becomes less acute, it is important to now start rolling these measures back promptly in line with the fall in energy prices and in a concerted manner. Any such measures falling short of these principles are likely to drive up medium-term inflationary pressures, which would call for a stronger monetary policy response. Moreover, in line with the EU s economic governance framework, fiscal policies should be oriented towards making the economy more productive and gradually bringing down high public debt. Policies to enhance the euro area s supply capacity, especially in the energy sector, can help reduce price pressures in the medium term. To that end, governments should swiftly implement their investment and structural reform plans under the Next Generation EU programme. The reform of the EU s economic governance framework should be concluded rapidly. Inflation According to Eurostat s flash estimate, which has been calculated using Eurostat estimates for Germany, inflation was 8.5% in January. This would be 0.7 percentage points lower than the December figure, with the decline owing mainly to a renewed sharp drop in energy prices. Market-based indicators suggest that energy prices over the coming years will be significantly lower than expected at the time of the December 2022 meeting. Food price inflation edged higher to 14.1%, as the past surge in the Economic Bulletin, Issue 1/2023   Update on economic, financial and monetary developments Summary 3 cost of energy and of other inputs for food production is still feeding through to consumer prices. Price pressures remain strong, partly because high energy costs are spreading throughout the economy. Inflation excluding energy and food remained at 5.2% in January, with inflation for non-energy industrial goods rising to 6.9% and services inflation declining to 4.2%. Other indicators of underlying inflation are also still high. Government measures to compensate households for high energy prices will dampen inflation in 2023 but are expected to raise inflation once they expire. At the same time, the scale of some of these measures depends on the evolution of energy prices and their expected contribution to inflation is particularly uncertain. Although supply bottlenecks are gradually easing, their delayed effects are still pushing up goods price inflation. The same holds true for the lifting of pandemic-related restrictions: while weakening, the effect of pent-up demand is still driving up prices, especially in the services sector. Wages are growing faster, supported by robust labour markets, with some catch-up to high inflation becoming the main theme in wage negotiations. At the same time, recent data on wage dynamics have been in line with the December 2022 Eurosystem staff projections. Most measures of longer-term inflation expectations currently stand at around 2%, but these warrant continued monitoring. Risk assessment The risks to the outlook for economic growth have become more balanced. Russia s unjustified war against Ukraine and its people continues to be a significant downside risk to the economy and could again push up the costs of energy and food. There could also be an additional drag on euro area growth if the world economy weakened more sharply than expected. Moreover, the recovery would face obstacles if the pandemic were to re-intensify and cause renewed supply disruptions. However, the energy shock could fade away faster than anticipated and euro area companies could adapt more quickly to the challenging international environment. This would support higher growth than currently expected. The risks to the inflation outlook have also become more balanced, especially in the near term. On the upside, existing pipeline pressures could still send retail prices higher in the near term. Moreover, a stronger than expected economic rebound in China could give a fresh boost to commodity prices and foreign