European Central Bank — Economic Bulletin (Europe, 2017)

Economic Bulletin Issue 6 / 2017 Contents Economic and monetary developments Overview 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 5 6 7 Investment dynamics in advanced economies since the financial crisis Liquidity conditions and monetary policy operations in the period from 3 May to 25 July 2017 Recent developments in euro area labour supply Reducing unemployment from a historical perspective Structural reform needs in the euro area: insights from a survey of large companies The role of base effects in the projected path of HICP inflation Base money, broad money and the APP Article 1 Modelling euro banknote quality Box 1 Modelling country-specific cash cycles based on real data Statistics 2 2 5 10 15 21 26 33 35 35 40 44 50 54 59 62 66 66 87 S1 ECB Economic Bulletin, Issue 6 / 2017 - Economic and monetary developments Contents 1 Economic and monetary developments Overview At its monetary policy meeting on 7 September 2017, the Governing Council assessed that while the ongoing economic expansion provides confidence that inflation will gradually head to levels in line with its inflation aim, it has yet to translate sufficiently into stronger inflation dynamics. The economic expansion, which accelerated more than expected in the first half of 2017, continues to be solid and broad-based across countries and sectors. At the same time, the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability. Measures of underlying inflation have ticked up slightly in recent months but, overall, remain at subdued levels. Therefore, a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to gradually build up and support headline inflation developments in the medium term. The Governing Council thus maintained its monetary stance and will decide in the autumn on the calibration of the policy instruments beyond the end of the year. Economic and monetary assessment at the time of the Governing Council meeting of 7 September 2017 The euro area economic expansion is continuing and becoming increasingly resilient, with the ECB s monetary policy measures supporting domestic demand. Euro area real GDP increased by 0.6%, quarter on quarter, in the second quarter of 2017, after 0.5% in the first quarter. Real GDP growth is supported primarily by domestic demand. Private consumption is underpinned by employment gains, which are also benefiting from past labour market reforms, and by increasing household wealth. The recovery in investment continues to benefit from very favourable financing conditions and improvements in corporate profitability. Surveys and short-term indicators confirm the outlook for robust growth momentum in the near term. The broad-based global recovery will support euro area exports. Global economic activity is projected to accelerate moderately, underpinned by continued monetary and fiscal policy support in advanced economies and a recovery in commodity-exporting emerging market economies. After showing a marked improvement at the turn of the year, global trade has softened recently, but leading indicators continue to signal positive prospects. Overall, the broad-based global recovery will mitigate the potential impact on exports of a stronger exchange rate, which has appreciated by 3.4% in trade-weighted terms since the Governing Council s monetary policy meeting in June. The September 2017 ECB staff macroeconomic projections for euro area real GDP growth are 2.2% in 2017, 1.8% in 2018 and 1.7% in 2019. Compared with the ECB Economic Bulletin, Issue 6 / 2017 - Economic and monetary developments Overview 2 June 2017 Eurosystem staff projections, the expected growth rates have been revised up for 2017 and are broadly unchanged thereafter. Risks surrounding the euro area growth outlook remain broadly balanced. On the one hand, the current positive cyclical momentum increases the chances of a stronger than expected economic upswing. On the other hand, downside risks continue to exist, primarily relating to global factors and developments in foreign exchange markets. According to Eurostat s flash estimate, euro area annual HICP inflation in August 2017 was 1.5%, up from 1.3% in July. This reflected higher energy and, to a lesser extent, higher processed food inflation. On the basis of current oil futures prices, annual rates of headline inflation are likely to temporarily decline towards the turn of the year, mainly reflecting base effects in energy prices, before rising again. While measures of underlying inflation have ticked up moderately in recent months, they have yet to show convincing signs of a sustained upward trend. According to Eurostat s flash estimate, HICP inflation excluding energy and food was 1.2% in August, unchanged from July, but 0.4 percentage point higher than the average for the final quarter of 2016. Domestic cost pressures, notably from labour markets, are still subdued. Underlying inflation in the euro area is expected to rise gradually over the medium term, supported by the ECB s monetary policy measures, the continuing economic expansion, and the corresponding gradual absorption of economic slack and rising wages. The September 2017 ECB staff macroeconomic projections for the euro area foresee annual HICP inflation at 1.5% in 2017, 1.2% in 2018 and 1.5% in 2019. Compared with the June 2017 Eurosystem staff macroeconomic projections, the outlook for headline HICP inflation has been revised down slightly, mainly reflecting the recent appreciation of the euro exchange rate. The euro area budget deficit is foreseen to decline further over the projection horizon (2017-19) owing to improving cyclical conditions and decreasing interest payments. Based on the September 2017 ECB staff macroeconomic projections, the general government deficit ratio for the euro area is expected to fall from 1.5% of GDP in 2016 to 0.9% of GDP in 2019.Structural deficits, however, are not declining, despite the favourable growth dynamics. Money growth remained robust despite some monthly volatility. The recovery in the growth of loans to the private sector has been proceeding. At the same time, the annual flow of total external financing to non-financial corporations is estimated to have eased somewhat in the second quarter of 2017. The pass-through of the monetary policy measures put in place in recent years continues to significantly support borrowing conditions. Euro area sovereign bond yields have remained broadly unchanged since the Governing Council s monetary policy meeting in June. Corporate bond spreads vis- -vis the risk-free rate have declined marginally and remain below the levels observed in early March 2016 when the corporate sector purchase programme was announced. ECB Economic Bulletin, Issue 6 / 2017 - Economic and monetary developments Overview 3 Monetary policy decisions Taking into account the outcome of the economic analysis and the signals coming from the monetary analysis, the Governing Council concluded that a continued very substantial degree of monetary accommodation is needed to secure a sustained return of inflation rates towards levels that are below, but close to, 2%. The Governing Council decided to keep the key ECB interest rates unchanged and expects them to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases. Regarding non- standard monetary policy measures, the Governing Council confirmed that the net asset purchases, at the current monthly pace of  60 billion, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. The net purchases are made alongside reinvestments of the principal payments from maturing securities purchased under the asset purchase programme (APP). In addition, the Governing Council reconfirmed its commitment to increase the APP in terms of size and/or duration if the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation. This autumn the Governing Council will decide on the calibration of the policy instruments beyond the end of the year, taking into account the expected path of inflation and the financial conditions needed for a sustained return of inflation rates towards levels that are below, but close to, 2%. ECB Economic Bulletin, Issue 6 / 2017 - Economic and monetary developments Overview 4 1 External environment The global economy is continuing to expand at a solid rate. After a temporary dip in momentum in some countries at the start of the year, data point to a rebound in global GDP growth. Looking ahead, global economic activity is projected to accelerate moderately, underpinned by continued monetary and fiscal policy support in advanced economies and a recovery in commodity-exporting emerging market economies. After showing a marked improvement at the turn of the year, global trade has softened recently, but leading indicators continue to signal positive prospects. Global inflation is expected to rise as spare capacity at the global level diminishes. Global economic activity and trade The global economy has continued to expand steadily. Following a temporary dip in growth in some economies in the first quarter, the latest data and survey- based indicators show a rebound in global growth. With