European Central Bank — Economic Bulletin (Europe, 2023)

Economic Bulletin Issue 6 / 2023 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 Risks to global food commodity prices from El Ni o What role do reopening effects play across countries and sectors? The euro area labour force: recent developments and drivers What do consumers think is the main driver of recent inflation? Climate change and euro area firms  green investment and financing   results from the SAFE Liquidity conditions and monetary policy operations from 10 May to 1 August 2023 Banks  capital distributions and implications for monetary policy The fiscal impact of financial sector support measures 15 years after the great financial crisis Articles 1 The euro area current account after the pandemic and energy shock Box 1 Introducing product group breakdowns and price-quantity decompositions for goods trade in the euro area balance of payments Box 2 A medium-term current account benchmark for the euro area ECB Economic Bulletin, Issue 6 / 2023   Contents 3 3 8 14 23 30 36 44 48 48 53 59 64 70 79 85 92 96 96 103 109 1 2 How climate change affects potential output Box 1 Empirical evidence on the impact of carbon taxes on potential output growth in Europe Box 2 Testing the Porter hypothesis: environmental regulation and productivity growth in the euro area Box 3 Economic activity s reliance on nature 3 SESFOD@10   credit terms and conditions in euro- denominated securities financing and over-the-counter derivatives markets since 2013 Box 1 Market structure and sample representativeness Box 2 Comparison between SESFOD and SCOOS responses on hedge funds Statistics 113 120 123 126 129 140 145 S1 ECB Economic Bulletin, Issue 6 / 2023   Contents 2 Economic, financial and monetary developments Overview Inflation continues to decline but is still expected 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. In order to reinforce progress towards its target, the Governing Council decided at its meeting on 14 September 2023 to raise the three key ECB interest rates by 25 basis points. The rate increase reflects the Governing Council s 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 September 2023 ECB staff macroeconomic projections for the euro area see average inflation at 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025. This is an upward revision for 2023 and 2024 and a downward revision for 2025. The upward revision for 2023 and 2024 mainly reflects a higher path for energy prices. Underlying price pressures remain high, even though most indicators have started to ease. ECB staff have slightly revised down the projected path for inflation excluding energy and food, to an average of 5.1% in 2023, 2.9% in 2024 and 2.2% in 2025. The Governing Council s past interest rate increases continue to be transmitted forcefully. Financing conditions have tightened further and are increasingly dampening demand, which is an important factor in bringing inflation back to target. With the increasing impact of this tightening on domestic demand and the weakening international trade environment, ECB staff have lowered their economic growth projections significantly. They now expect the euro area economy to expand by 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025. Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target. The Governing Council s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive 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, the Governing Council s interest rate decisions will 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. Economic activity The economy is likely to remain subdued in the coming months. It broadly stagnated over the first half of the year, and recent indicators suggest it has also been weak in ECB Economic Bulletin, Issue 6 / 2023   Economic, financial and monetary developments Overview 3 the third quarter. Lower demand for the euro area s exports and the impact of tight financing conditions are dampening growth, including through lower residential and business investment. The services sector, which had so far been resilient, is now also weakening. Over time, economic momentum should pick up, as real incomes are expected to rise, supported by falling inflation, rising wages and a strong labour market, and this will underpin consumer spending. The labour market has so far remained resilient despite the slowing economy. The unemployment rate stayed at its historical low of 6.4% in July. While employment grew by 0.2% in the second quarter, momentum is slowing. The services sector, which has been a major driver of employment growth since mid-2022, is now also creating fewer jobs. The short-term outlook for growth in the euro area has deteriorated, while over the medium term the economy should gradually return to moderate growth as both domestic and foreign demand recover. Euro area economic activity grew at a subdued pace in the first half of 2023, despite the elevated level of manufacturing order backlogs and the unwinding of high energy prices. Moreover, these effects have largely waned, and short-term indicators point to stagnation in the near term in the face of tighter financing conditions, weak business and consumer confidence and low foreign demand in the context of a strengthening of the euro. Growth is expected to pick up from 2024 as foreign demand approaches its pre-pandemic trend and real incomes improve, underpinned by declining inflation, strong nominal wage growth and still low, though slightly increasing, unemployment. However, growth will continue to be dampened as the ECB s monetary policy tightening and adverse credit supply conditions feed through to the real economy and as fiscal support is gradually withdrawn. Overall, annual average real GDP growth is expected to slow down from 3.4% in 2022 to 0.7% in 2023, before recovering to 1.0% in 2024 and to 1.5% in 2025. Compared with the June 2023 Eurosystem staff projections, the outlook for GDP growth has been revised down by 0.2 percentage points for 2023, 0.5 percentage points for 2024 and 0.1 percentage points for 2025, reflecting a significant downgrade of the short-term outlook, amid deteriorating survey indicators, tighter financing conditions   including more adverse credit supply effects   and the stronger euro exchange rate. As the energy crisis fades, governments should continue to roll back the related support measures. This is essential to avoid driving up medium-term inflationary pressures, which would otherwise call for an even stronger monetary policy response. Fiscal policies should be designed to make the euro area economy more productive and to gradually bring down high public debt. Policies to enhance the euro area s supply capacity   which would be supported by the full implementation of the Next Generation EU programme   can help reduce price pressures in the medium term, while supporting the green transition. The reform of the EU s economic governance framework should be concluded before the end of 2023 and progress towards capital markets union should be accelerated. ECB Economic Bulletin, Issue 6 / 2023   Economic, financial and monetary developments Overview 4 Inflation Inflation declined to 5.3% in July but remained at that level in August, according to Eurostat s flash estimate.1 Its decline was interrupted because energy prices rose compared with July. Food price inflation has come down from its peak in March but was still almost 10% in August. In the coming months, the sharp price increases recorded in the autumn of 2022 will drop out of the yearly rates, thus pulling inflation down. Inflation excluding energy and food fell to 5.3% in August, from 5.5% in July. Goods inflation declined to 4.8% in August, from 5.0% in July and 5.5% in June, owing to better supply conditions, previous drops in energy prices, easing price pressures in the earlier stages of the production chain and weaker demand. Services inflation edged down to 5.5% but was still kept up by strong spending on holidays and travel and by the high growth of wages. The annual growth rate of compensation per employee remained constant at 5.5% in the second quarter of the year. The contribution of labour costs to annual domestic inflation increased in the second quarter, in part owing to weaker productivity, while the contribution of profits fell for the first time since early 2022. Most measures of underlying inflation are starting to fall as demand and supply have become more aligned and the contribution of past energy price increases is fading out. At the same time, domestic price pressures remain strong. Most measures of longer-term inflation expectations currently stand at around 2%. But some indicators have increased and need to be monitored closely. Headline inflation in the euro area is p