European Central Bank — Economic Bulletin (Europe, 2023)

Economic Bulletin Issue 4 / 2023 Contents Contents Economic, financial and monetary developments Overview External environment Economic activity Prices and costs Financial market developments Financing conditions and credit developments Fiscal developments 1 2 3 4 5 6 Boxes 1 2 3 4 5 6 7 8 The consumption impulse from pandemic savings   does the composition matter? Earnings calls: new evidence on corporate profits, investment and financing conditions How have unit profits contributed to the recent strengthening of euro area domestic price pressures? The development of the wage share in the euro area since the start of the pandemic Selling price expectations of firms   evidence from the SAFE The great retrenchment in euro area external financial flows in 2022   insights from more granular balance of payments statistics Liquidity conditions and monetary policy operations from 8 February to 9 May 2023 Inflation and competitiveness divergences in the euro area countries Article 1 The role of supply and demand in the post-pandemic recovery in the euro area Economic Bulletin, Issue 4/2023   Contents 1 3 3 9 16 24 31 37 46 50 50 56 62 71 76 81 88 94 99 99 1 Box 1 A comparison of economic developments in the euro area and the United States since the pandemic Box 2 The impact of discretionary fiscal policy measures on real GDP growth from 2020 to 2022 Box 3 A model-based assessment of the drivers of economic activity Statistics 107 108 115 S1 Economic Bulletin, Issue 4/2023   Contents 2 Economic, financial and monetary developments Overview Inflation has been coming down but is projected to remain too high for too long. The Governing Council is determined to ensure that inflation returns to its 2% medium- term target in a timely manner. It therefore decided at its meeting on 15 June 2023 to raise the three key ECB interest rates by 25 basis points. The rate increase reflects the Governing Council s updated assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission. According to the June 2023 Eurosystem staff macroeconomic projections for the euro area headline inflation is expected to average 5.4% in 2023, 3.0% in 2024 and 2.2% in 2025. Indicators of underlying price pressures remain strong, although some show tentative signs of softening. Staff have revised up their projections for inflation excluding energy and food, especially for this year and next year, owing to past upward surprises and the implications of the robust labour market for the speed of disinflation. They now see it reaching 5.1% in 2023, before it declines to 3.0% in 2024 and 2.3% in 2025. Staff have slightly lowered their economic growth projections for this year and next year. They now expect the economy to grow by 0.9% in 2023, 1.5% in 2024 and 1.6% in 2025. At the same time, the Governing Council s past rate increases are being transmitted forcefully to financing conditions and are gradually having an impact across the economy. Borrowing costs have increased steeply and the growth in loans is slowing. Tighter financing conditions are a key reason why inflation is projected to decline further towards target, as they are expected to increasingly dampen demand. The Governing Council s future decisions will ensure that the key ECB interest rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary. The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, its interest rate decisions will continue to be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. The Governing Council confirmed that it would discontinue the reinvestments under the asset purchase programme (APP) as of July 2023. Economic activity The global economy started this year on a stronger footing than in the fourth quarter of 2022 thanks to the reopening of the Chinese economy and the resilience of labour Economic Bulletin, Issue 4/2023   Economic, financial and monetary developments Overview 3 markets in the United States. Global activity was mainly driven by the services sector, whereas manufacturing output remains relatively subdued. The fallout from the US banking sector woes in early March led to a brief period of acute stress in global financial markets. Since then, most asset prices have recovered the losses recorded during that period, while financial market participants also revised down their expectations for the future path of the Federal Reserve System s monetary policy tightening. Nonetheless, lingering uncertainty is adding to global growth headwinds, including high inflation, tightening in global financial conditions and geopolitical tensions. Against this backdrop, the global growth and inflation outlook in the June 2023 projections remains broadly unchanged compared with the March 2023 ECB staff macroeconomic projections for the euro area. The small upward revision to global growth in 2023 is mainly related to the stronger than previously expected recovery in demand in China in the first quarter, which was partially offset by the adverse impact of tighter financial and credit conditions in the United States and other advanced economies. The inflation outlook has been revised slightly upwards for 2024 against the backdrop of tight labour markets and still high wage growth in advanced economies, while lower commodity prices explain a small downward revision to projected inflation for 2023. World trade is projected to grow at a much slower pace than real GDP this year, as the composition of global demand has become less trade-intensive. The outlook for world trade for 2023 was revised down, albeit largely on account of sizeable negative carry-over effects from the fourth quarter of 2022 and weak outturns in major economies in the first quarter. The euro area economy has stagnated in recent months. As in the fourth quarter of last year, it shrank by 0.1% in the first quarter of 2023, amid a drop in private and public consumption. Economic growth is likely to remain weak in the short run but strengthen in the course of the year, as inflation comes down and supply disruptions continue to ease. Conditions in different sectors of the economy are uneven: manufacturing continues to weaken, partly owing to lower global demand and tighter euro area financing conditions, while services remain resilient. The labour market remains a source of strength. Almost a million new jobs were added in the first quarter of the year and the unemployment rate stood at a historical low of 6.5% in April. The average number of hours worked has also increased, although it is still somewhat below its pre-pandemic level. According to the June 2023 projections, the economy is expected to return to growth in the coming quarters as energy prices moderate, foreign demand strengthens and supply bottlenecks are resolved, allowing firms to continue to work through their significant order backlogs, and as uncertainty   including that related to the recent banking sector stress   continues to recede. Furthermore, real incomes are set to improve, underpinned by the robust labour market, with unemployment hitting new historical lows over the projection horizon. The ECB s monetary policy tightening will increasingly feed through to the real economy. Together with the gradual withdrawal of fiscal support, this will weigh on economic growth in the medium term. Overall, annual average real GDP growth is expected to slow down to 0.9% in 2023 (from 3.5% in 2022), before rebounding to 1.5% in 2024 and 1.6% in 2025. Compared with the March 2023 projections, the outlook for GDP growth has been revised down by Economic Bulletin, Issue 4/2023   Economic, financial and monetary developments Overview 4 0.1 percentage points for 2023 and 2024, reflecting mainly tighter financing conditions. GDP growth in 2025 remains unchanged, as these effects are expected to be partly offset by the impact of higher real disposable income and lower uncertainty. The euro area fiscal outlook is set to improve over the projection horizon. After the significant decline in 2022, the euro area budget deficit is projected to continue to decline at a slower pace over 2023-24 and only marginally in 2025 (to 2.5% of GDP). The decline in the budget balance at the end of the projection horizon, compared with 2022, is explained by the improvement in the cyclically adjusted primary balance and, to a more limited extent, by a better cyclical fiscal component, while interest payments gradually increase as a share of GDP over the horizon. Euro area debt is projected to continue to decline, albeit more slowly after 2022, to stand at 87.3% of GDP by 2025. This is mainly on account of negative interest rate-growth differentials, which more than offset the persisting primary deficits. Nevertheless, in 2025 both the deficit and debt ratios are expected to remain above pre-pandemic levels. Compared with the March 2023 projections, the budget balance remains broadly unchanged at the end of the horizon, while the debt ratio has been revised up somewhat over 2023-25 mainly on account of less favourable interest rate-growth differentials. As the energy crisis fades, governments should roll back the related support measures promptly and in a concerted manner to avoid driving up medium-term inflationary pressures, which would call for a stronger monetary policy response