European Central Bank — Economic Bulletin (Europe, 2022)

Economic Bulletin Issue 6 / 2022 Contents Economic, financial and monetary developments Overview 1 2 3 4 5 6 External environment Economic activity Prices and costs Financial market developments Financing conditions and credit developments Fiscal developments Boxes 1 2 3 4 5 6 The role of public employment during the COVID-19 crisis COVID-19 and retirement decisions of older workers in the euro area Does the tail wag the dog? A closer look at recent movements in the distributions of inflation expectations The impact of rising mortgage rates on the euro area housing market Liquidity conditions and monetary policy operations from 20 April to 26 July 2022 Common minimum standards for incorporating climate change risks into in-house credit assessment systems in the Eurosystem Article 1 Fiscal policies to mitigate climate change in the euro area Statistics 2 2 8 14 21 29 33 42 46 46 51 56 60 65 71 75 75 S1 ECB Economic Bulletin, Issue 6 / 2022   Contents 1 Economic, financial and monetary developments Overview On 8 September 2022 the Governing Council decided to raise the three key ECB interest rates by 75 basis points. This major step frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to the Governing Council s 2% medium-term target. Based on the Governing Council s updated assessment, over the next several meetings it expects to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations. The Governing Council will regularly re-evaluate its policy path in light of incoming information and the evolving inflation outlook. Its future policy rate decisions will continue to be data- dependent and follow a meeting-by-meeting approach. The Governing Council took this decision, and expects to raise interest rates further, because inflation remains far too high and is likely to stay above its target for an extended period. According to Eurostat s flash estimate, inflation reached 9.1% in August. Soaring energy and food prices, demand pressures in some sectors owing to the reopening of the economy, and supply bottlenecks are still driving up inflation. Price pressures have continued to strengthen and broaden across the economy and inflation may rise further in the near term. As the current drivers of inflation fade over time and the normalisation of monetary policy works its way through to the economy and price-setting, inflation will come down. Looking ahead, ECB staff have significantly revised up their inflation projections and inflation is now expected to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024. After a rebound in the first half of 2022, recent data point to a substantial slowdown in euro area economic growth, with the economy expected to stagnate later in the year and in the first quarter of 2023. Very high energy prices are reducing the purchasing power of people s incomes and, although supply bottlenecks are easing, they are still constraining economic activity. In addition, the adverse geopolitical situation, especially Russia s unjustified aggression towards Ukraine, is weighing on the confidence of businesses and consumers. This outlook is reflected in the latest staff projections for economic growth, which have been revised down markedly for the remainder of the current year and throughout 2023. Staff now expect the economy to grow by 3.1% in 2022, 0.9% in 2023 and 1.9% in 2024. The lasting vulnerabilities caused by the pandemic still pose a risk to the smooth transmission of monetary policy. The Governing Council will therefore continue applying flexibility in reinvesting redemptions coming due in the pandemic emergency purchase programme (PEPP) portfolio, with a view to countering risks to the transmission mechanism related to the pandemic. ECB Economic Bulletin, Issue 6 / 2022   Economic, financial and monetary developments Overview 2 Economic activity High inflation, tighter financial conditions and lingering supply-related headwinds are taking their toll on economic activity worldwide. Survey data signal a broad-based moderation in economic activity. According to the September 2022 ECB staff macroeconomic projections, the global growth outlook is subdued, with global real GDP (excluding the euro area) projected to grow by 2.9% in 2022, 3.0% in 2023 and 3.4% in 2024. This outlook is weaker than that described in the June 2022 Eurosystem staff macroeconomic projections and implies that the global economy is expected to grow at a rate slightly below its long-term average this year and next year, as economic activity slows across advanced and emerging market economies. A weaker demand outlook and improved supply have helped to alleviate supply chain pressures, though they are still present. In line with global growth, the outlook for global trade and euro area foreign demand has also deteriorated compared with the June projections. Global inflationary pressures remain broad and elevated amid commodity price spikes, lingering supply constraints, still relatively robust demand and tight labour markets. These pressures are, however, expected to decline as commodity markets stabilise and growth weakens. In an environment of high uncertainty, the balance of risks around the baseline projections is tilted to the downside for global growth and to the upside for global inflation. The euro area economy grew by 0.8% in the second quarter of 2022, mainly owing to strong consumer spending on contact-intensive services, as a result of the lifting of pandemic-related restrictions. Over the summer, as people travelled more, countries with large tourism sectors benefited especially. At the same time, businesses suffered from high energy costs and continued supply bottlenecks, although the latter have been gradually easing. While buoyant tourism has been supporting economic growth during the third quarter, the Governing Council expects the economy to slow down substantially over the remainder of this year. There are four main reasons behind this. First, high inflation is dampening spending and production throughout the economy, and these headwinds are reinforced by gas supply disruptions. Second, the strong rebound in demand for services that came with the reopening of the economy will lose steam in the coming months. Third, the weakening in global demand, also in the context of tighter monetary policy in many major economies, and the worsening terms of trade will mean less support for the euro area economy. Fourth, uncertainty remains high and confidence is falling sharply. At the same time, the labour market has remained robust, supporting economic activity. Employment increased by more than 600,000 people in the second quarter of 2022 and the unemployment rate stood at a historical low of 6.6% in July. Total hours worked increased further, by 0.6%, in the second quarter of 2022 and have surpassed their pre-pandemic levels. Looking ahead, the slowing economy is likely to lead to some increase in the unemployment rate. The euro area baseline scenario of the September 2022 ECB staff macroeconomic projections rests on the assumptions that gas demand will be tempered by high prices and precautionary energy saving measures (following the recent EU ECB Economic Bulletin, Issue 6 / 2022   Economic, financial and monetary developments Overview 3 agreement to reduce gas demand by up to 15%) and that no major rationing of gas will be needed. Nevertheless, some production cuts are assumed to be necessary in the winter in countries that are heavily dependent on imports of Russian natural gas and at risk of a shortfall in supply. Although supply bottlenecks have recently eased somewhat faster than had been expected, they are still weighing on activity and are assumed to dissipate only gradually. Over the medium term as the energy market rebalances, uncertainty declines, supply bottlenecks are resolved and real incomes improve, growth is expected to rebound, despite less favourable financing conditions. The labour market is expected to weaken following the slowdown in economic activity, though remaining overall rather resilient. Overall, according to the September 2022 ECB staff projections, annual average real GDP growth is expected to stand at 3.1% in 2022, to slow down markedly to 0.9% in 2023 and to rebound to 1.9% in 2024. Compared with the June 2022 Eurosystem staff projections, the outlook for GDP growth has been revised up by 0.3 percentage points for 2022, following positive surprises in the first half of the year, and revised down by 1.2 percentage points for 2023 and by 0.2 percentage points for 2024, mainly owing to the impact of energy supply disruptions, higher inflation and the related fall in confidence. According to the September 2022 ECB staff macroeconomic projections, the euro area budget balance is projected to improve steadily in the period up to 2024, although by somewhat less than foreseen in the June projections. However, the fiscal projections continue to be surrounded by high levels of uncertainty, mainly related to the war in Ukraine and developments in energy markets that could lead governments to adopt additional fiscal stimulus measures. Such fiscal support measures have been largely aimed at countering the rising cost of living for consumers, particularly in relation to energy. Moreover, the financing of new defence capacities and support for refugees from Russia s war in Ukraine have also played a role. Nevertheless, the euro area government budget deficit is expected to continue to fall, declining from 5.1% of GDP in 2021 to 3.8% in 2022 and then to 2.7% by the end of the foreca