European Central Bank — Economic Bulletin (Europe, 2021)

Economic Bulletin Issue 3 / 2021 Contents Update on 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 What is driving the recent surge in shipping costs? Main findings from the ECB s recent contacts with non-financial companies Macroeconomic implications of heterogeneous long-term inflation expectations: illustrative simulations through the ECB-BASE Recent dynamics in energy inflation: the role of base effects and taxes Articles 1 2 3 Understanding post-referendum weakness in UK import demand and UK balance of payments risks for the euro area The role of households in financing government debt in the euro area Liquidity usage in TARGET2 Statistics 2 2 5 8 11 16 21 26 26 33 36 41 45 45 63 82 S1 ECB Economic Bulletin, Issue 3 / 2021   Contents 1 Update on economic and monetary developments Summary While the recovery in global demand and the sizeable fiscal stimulus are supporting global and euro area activity, the near-term economic outlook remains clouded by uncertainty about the resurgence of the pandemic and the roll-out of vaccination campaigns. Persistently high rates of coronavirus (COVID-19) infection and the associated extension and tightening of containment measures continue to constrain economic activity in the short term. Looking ahead, progress with vaccination campaigns and the envisaged gradual relaxation of containment measures reinforce the expectation of a firm rebound in economic activity in the course of 2021. Inflation has picked up over recent months on account of some idiosyncratic and temporary factors and an increase in energy price inflation. At the same time, underlying price pressures remain subdued in the context of significant economic slack and still weak demand. Preserving favourable financing conditions over the pandemic period remains essential to reduce uncertainty and bolster confidence, thereby underpinning economic activity and safeguarding medium-term price stability. Euro area financing conditions have remained broadly stable recently after the increase in market interest rates earlier in the year, but risks to wider financing conditions remain. Against this background, the Governing Council decided to reconfirm its very accommodative monetary policy stance. Global economic activity remained on a solid recovery path at the turn of 2020-21, despite the re-intensification of the pandemic. Supplier delivery times have lengthened on the back of strong global demand. The recovery in trade also continued, with merchandise trade remaining the main driving factor, and services trade showing signs of improvement. Global financial conditions continued to be highly accommodative, with equity markets underpinned by optimism about global growth prospects and continued monetary policy support. Over the review period (11 March to 21 April 2021) the forward curve of the euro overnight index average (EONIA) was broadly unchanged, suggesting no market expectations of an imminent policy rate change in either direction. Long-term sovereign bond yields in the euro area increased somewhat, but have remained relatively stable overall since March. Non-financial corporations  equity prices increased on both sides of the Atlantic and reached new post-financial crisis highs. In foreign exchange markets, the nominal effective exchange rate of the euro appreciated slightly. Euro area real GDP declined by 0.7% in the fourth quarter of 2020 to stand 4.9% below its pre-pandemic level one year earlier. Incoming economic data, surveys and high-frequency indicators suggest that economic activity may have contracted again in ECB Economic Bulletin, Issue 3 / 2021   Update on economic and monetary developments Summary 2 the first quarter of this year, but point to a resumption of growth in the second quarter. Business surveys indicate that the manufacturing sector continues to recover, supported by solid global demand. At the same time, restrictions on mobility and social interaction still limit activity in the services sector, although there are signs of a bottoming-out. Fiscal policy measures continue to support households and firms, but consumers remain cautious in view of the pandemic and its impact on employment and earnings. Despite weaker corporate balance sheets and elevated uncertainty about the economic outlook, business investment has shown resilience. Looking ahead, the progress with vaccination campaigns, which should allow for a gradual relaxation of containment measures, should pave the way for a firm rebound in economic activity in the course of 2021. Over the medium term the recovery of the euro area economy is expected to be driven by a recovery in domestic and global demand, supported by favourable financing conditions and fiscal stimulus. Euro area annual inflation increased to 1.3% in March 2021, from 0.9% in February, on account of a strong increase in energy price inflation that reflected both a sizeable upward base effect and a month-on-month increase. This increase more than offset decreases in food price inflation and in HICP inflation excluding energy and food. Headline inflation is likely to increase further in the coming months, but some volatility is expected throughout the year reflecting the changing dynamics of idiosyncratic and temporary factors. These factors can be expected to fade out of annual inflation rates early next year. Underlying price pressures are expected to increase somewhat this year, owing to short-term supply constraints and the recovery in domestic demand, although they remain subdued overall, in part reflecting low wage pressures, in the context of economic slack, and the appreciation of the euro exchange rate. Once the impact of the pandemic fades, the unwinding of the high level of slack, supported by accommodative fiscal and monetary policies, will contribute to a gradual increase in inflation over the medium term. Survey-based measures and market-based indicators of longer-term inflation expectations remain at subdued levels, although market-based indicators have continued their gradual increase. In February 2021, money growth was robust, driven by domestic credit expansion, especially via Eurosystem asset purchases. While growth in lending to firms has been broadly unchanged since June 2020, loan flows point to a moderation in loan dynamics in recent months as demand for loans has abated, while some signs of a tightening in credit supply have also emerged. The euro area bank lending survey for the first quarter of 2021 reports a moderate tightening of credit standards for loans to firms, following more significant tightening in the previous two quarters. Bank lending rates have continued to hover close to their historical lows. Against this background, the Governing Council decided to reconfirm its very accommodative monetary policy stance. First, the Governing Council decided to keep the key ECB interest rates unchanged. They are expected to remain at their present or lower levels until the inflation outlook robustly converges to a level sufficiently close to, but below, 2% within the projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics. ECB Economic Bulletin, Issue 3 / 2021   Update on economic and monetary developments Summary 3 Second, the Governing Council will continue the purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of  1,850 billion until at least the end of March 2022 and, in any case, until the Governing Council judges that the coronavirus crisis phase is over. Since the incoming information confirmed the joint assessment of financing conditions and the inflation outlook carried out at the March monetary policy meeting, the Governing Council expects purchases under the PEPP over the current quarter to continue to be conducted at a significantly higher pace than during the first months of the year. The Governing Council will purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation. In addition, the flexibility of purchases over time, across asset classes and among jurisdictions will continue to support the smooth transmission of monetary policy. If favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full. Equally, the envelope can be recalibrated if required to maintain favourable financing conditions to help counter the negative pandemic shock to the path of inflation. The Governing Council will continue to reinvest the principal payments from maturing securities purchased under the PEPP until at least the end of 2023. In any case, the future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance. Third, net purchases under the asset purchase programme (APP) will continue at a monthly pace of  20 billion. The Governing Council continues to expect monthly net asset purchases under the APP to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates. The Governing Council also intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when it starts raising the key ECB interest rates, and in any case for as long as necessary to maintain f