Update on economic and monetary developments

Summary

The incoming information that has become available since the Governing Council’s monetary policy meeting in September, while somewhat weaker than expected, remains overall consistent with an ongoing broad-based expansion of the euro area economy and gradually rising inflation pressures. The risks surrounding the euro area growth outlook can still be assessed as broadly balanced. At the same time, risks relating to protectionism, vulnerabilities in emerging markets and financial market volatility remain prominent. Yet, the underlying strength of the economy continues to support the Governing Council’s confidence that the sustained convergence of inflation to its aim will continue in the period ahead and will be maintained even after a gradual winding-down of the net asset purchases. Nevertheless, significant monetary policy stimulus is still needed to support the further build-up of domestic price pressures and headline inflation developments over the medium term. This support will continue to be provided by the net asset purchases until the end of the year, by the sizeable stock of acquired assets and the associated reinvestments, and by the Governing Council’s enhanced forward guidance on the key ECB interest rates. In any event, the Governing Council stands ready to adjust all of its instruments as appropriate to ensure that inflation continues to move towards its aim in a sustained manner.

Survey indicators of global economic growth have weakened recently as the global economic cycle matures. The global trade momentum has moderated amid ongoing actions and threats regarding trade tariff increases by the United States and possible retaliation by affected countries, but the near-term outlook remains steady. Global financial conditions remain supportive for advanced economies, while creating headwinds for emerging market economies.

In the euro area, sovereign bond yields have risen amid an increase in global risk-free rates and rising tensions in the sovereign debt markets of some euro area countries. Euro area equity prices have declined, reflecting a deterioration in risk sentiment. By contrast, yield spreads on corporate bonds have remained broadly unchanged. In foreign exchange markets, the euro has been broadly stable in trade-weighted terms.

Euro area real GDP increased by 0.4%, quarter on quarter, in both the first and the second quarter of 2018. Looking ahead, the incoming information remains overall consistent with the Governing Council’s baseline scenario of an ongoing broad-based economic expansion. However, some recent sector-specific developments are having an impact on the near-term growth profile. The ECB’s monetary policy measures continue to underpin domestic demand. Private consumption is fostered by ongoing employment growth and rising wages. Business investment is supported by solid domestic demand, favourable financing conditions and corporate profitability. Housing investment remains robust. In addition, the expansion in global activity is expected to continue supporting euro area exports, though at a slower pace.

Euro area annual HICP inflation increased to 2.1% in September 2018, from 2.0% in August, reflecting mainly higher energy and food price inflation. On the basis of current futures prices for oil, annual rates of headline inflation are likely to hover around the current level over the coming months. While measures of underlying inflation remain generally muted, they have been increasing from earlier lows. Domestic cost pressures are strengthening and broadening amid high levels of capacity utilisation and tightening labour markets. Looking ahead, underlying inflation is expected to pick up towards the end of the year and to increase further over the medium term, supported by the ECB’s monetary policy measures, the ongoing economic expansion and rising wage growth.

The monetary analysis shows that broad money (M3) growth stood at 3.5% in September 2018, after 3.4% in August. The growth of loans to the private sector has strengthened further, continuing the upward trend observed since the beginning of 2014. The euro area bank lending survey for the third quarter of 2018 indicates that loan growth continues to be supported by increasing demand across all loan categories and favourable bank lending conditions for loans to enterprises and loans for house purchase.

Combining the outcome of the economic analysis with the signals coming from the monetary analysis, the Governing Council concluded that an ample degree of monetary accommodation is still necessary for the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

On the basis of this assessment, the Governing Council decided to keep the key ECB interest rates unchanged and continues to expect them to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. Regarding non-standard monetary policy measures, the Governing Council confirmed that the Eurosystem will continue to make net purchases under the asset purchase programme (APP) at the new monthly pace of €15 billion until the end of December 2018. The Governing Council anticipates that, subject to incoming data confirming its medium-term inflation outlook, net purchases will then end. The Governing Council intends to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of the net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

External environment

Global survey indicators of economic growth have weakened recently as the global economic cycle matures. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area declined further below its long-term average in September (see Chart 1), reaching a two-year low. The decline was driven by both the manufacturing and the services components. In quarterly terms, the average PMI for the third quarter of 2018 declined from its level in the previous quarter. The composite output PMI decreased across most advanced economies, including the United States, Japan and the United Kingdom. In emerging market economies, it increased in India but weakened in China, Russia and Brazil, the latter country index remaining below the expansionary threshold.

Risks to the global economy remain to the downside, amid ongoing actions and threats regarding trade tariff increases by the United States and possible retaliation by the affected countries. The US administration implemented tariffs targeting an additional USD 200 billion of Chinese imports with effect from 24 September 2018, and China retaliated with tariffs targeting an additional USD 60 billion of exports from the United States. Given the size of these latest measures, uncertainty as to their impact has increased, in particular as regards business sentiment and capital spending plans. Policy uncertainty also remains high. While the United States is weighing additional tariffs on Chinese exports and an expansion of protectionist measures in the automotive sector, a new trade agreement between the United States, Mexico and Canada (USMCA) signals an easing of trade tensions. Overall, the risks to global growth from rising protectionism remain significant.

Global financial conditions remain supportive for advanced economies, while creating headwinds for emerging market economies. Overall, monetary policy in advanced economies remains accommodative. At the same time, in the United States the Federal Open Market Committee increased policy rates in September amid solid growth, rising inflation and a tight labour market. Following the decision, the yield on 10-year US government bonds reached its highest level since 2011, while international equity markets fell sharply. In China, financial conditions eased following action by the People’s Bank of China responding to a weakening outlook for economic activity amid rising trade tensions. More broadly, however, financial conditions in emerging market economies remain tight and weigh on the outlook for economic activity. Overall, global risk sentiment has not fully recovered over the past few months, and financial investors seem to increasingly discriminate against emerging market economies with significant imbalances, high external financing needs and limited room for policy support. Moreover, additional rate increases in the United States and the stronger dollar could lead to a further tightening of financial conditions across emerging market economies.

The global trade momentum has moderated, but the near-term outlook remains steady. Following very weak figures in the second quarter of the year, global merchandise imports further recovered in August on account of stronger imports by emerging market economies (see Chart 2). The global PMI for new export orders decreased to below expansionary territory in September; however, the average for the third quarter of the year remained above the neutral threshold. Other trade indicators give mixed signals. Overall, recent data point to moderate but steady growth in trade in the third quarter.

Global inflation was stable in August. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) was unchanged at 2.9% in August, while inflation excluding food and energy stood at 2.1%. Looking ahead, global inflationary pressures are expected to remain contained. While upward pressures from oil prices should diminish in the medium term, the gradual decline in spare economic capacity is expected to support underlying inflation.

Oil markets have been mainly affected by factors related to the US sanctions against Iran. Brent crude oil prices increased from a low of USD 70 per barrel in the summer to USD 86 per barrel on 3 October as the prospect of the sanctions started to affect Iranian oil exports and OPEC decided not to further increase production. The more recent retreat in oil prices to USD 76 per barrel on October 23 was driven by the announcements by Saudi Arabia and Russia that they could increase output if needed, coupled with a global stock market sell-off and weaker forecasts for oil demand growth. Non-oil commodity prices have decreased by around 2% since end-July. While food prices fell slightly, metal prices increased, mainly on account of iron ore prices.

In the United States, the outlook for economic activity remains solid. Real GDP expanded at an annualised rate of 4.2% in the second quarter of 2018, following 2.2% in the previous quarter. This marked acceleration was due in part to strong exports. To the extent that these exports were front-loaded in response to expected future tariffs, the support from trade is not expected to persist. In addition, the further escalation of trade tensions between the United States and China may increasingly affect business sentiment and thus investment spending. Nonetheless, the near-term outlook remains strong, supported by solid macroeconomic fundamentals, as well as a large procyclical fiscal expansion. Meanwhile, the labour market continued to generate jobs at a robust pace in September, and the unemployment rate declined further to 3.7%, the lowest rate since December 1969. Annual headline consumer price index (CPI) inflation slowed to 2.3% in September, while excluding food and energy, inflation remained at 2.2%.

In Japan, economic activity was robust in the second quarter, but extreme weather conditions have raised uncertainty regarding the outlook. Following a mild contraction in the first quarter of the year, economic activity rebounded in the second quarter, supported by strong investment activity. However, the outlook continues to be surrounded by growing uncertainty. Following the heavy rains and floods in western Japan in July, the impact of Typhoon Jebi and the Hokkaido earthquake in September are likely to weigh on economic activity. Looking further ahead, the Japanese economy is expected to return to moderate growth, albeit at a gradually slowing pace, as declining spare capacity and diminishing fiscal support may limit growth prospects in spite of accommodative monetary policy. In addition, the political uncertainty regarding trade policies remains significant, especially as regards potential tariffs on Japan’s automotive sector. Labour market indicators, meanwhile, point to a further tightening, while upward momentum in prices and wages remains limited. Annual headline CPI inflation stood at 1.2% in September, while CPI inflation excluding food and energy remained close to zero.

In the United Kingdom, real GDP growth rebounded modestly in the second quarter. Real GDP grew by 0.4% quarter on quarter in the second quarter, after first quarter growth was revised down to 0.1%. Household consumption slowed, while the investment and trade expenditure components were revised heavily downwards, revealing contractions in both for two consecutive quarters. The latest PMI survey data suggest quarter-on-quarter GDP growth at a similar rate in the third quarter, though short-term indicators for the export-oriented manufacturing sector signal a less optimistic outlook. This is in line with an environment of moderating global growth, growing trade tensions and the heightened uncertainty surrounding the outcome of the negotiations on the country’s withdrawal from membership of the European Union in March 2019. Having picked up slightly over the course of the summer, inflation fell back to 2.4% in September, from 2.7% in August. The volatility seen over the summer months was in large part expected, reflecting earlier developments in oil prices and a slight weakening in the pound around the end of the second quarter of the year.

In China, GDP growth moderated only slightly in the third quarter of 2018, amid additional policy support. Real GDP grew at 6.5% in year-on-year terms in the third quarter of 2018, supported by strong consumption, government policy support and a solid export performance. However, in the near term a slowing housing market and the lagged effects of earlier financial tightening may weigh on growth. Also, new tariffs implemented by the US administration targeting an additional USD 200 billion of Chinese exports to the United States are expected to adversely impact economic activity. In order to mitigate the impact, the Chinese authorities have announced a broad set of non-tariff measures to facilitate trade growth and foster domestic investment. In addition, Chinese policymakers are set to lower the average tariff rate on imports from 9.8% in 2017 to 7.5% as of 1 November. Headline CPI inflation increased slightly in September to 2.5%, but core inflation declined to 1.7%.

Financial developments

Euro area government bond yields have risen since mid-September (see Chart 3). In the period under review (from 13 September to 24 October 2018), the GDP-weighted euro area ten-year sovereign bond yield rose by 18 basis points to 1.28% amid an increase in global risk-free rates and rising tensions in the sovereign debt markets of some euro area countries. Vis-à-vis the yield on German ten-year government bonds, the spread on ten-year Italian sovereign bonds widened by 86 basis points to 3.22%. The spreads on the equivalent bonds of Spain and Portugal widened to a somewhat lesser extent. Sovereign bond yields increased by 20 basis points to 3.17% in the United States and declined by 3 basis points to 1.48% in the United Kingdom.

Broad indices of euro area equity prices declined. Equity prices of both euro area financials and non-financial corporations (NFCs) decreased by around 7% over the review period on the back of an increase in the discount rate and in risk premia in the light of tensions in euro area sovereign bond markets. However, expectations of robust corporate profits continued to be supportive of euro area equity prices. The equity prices of US NFCs and financial firms also declined over the review period, by 6% and 7.5% respectively. In view of the declines, market expectations of future equity price volatility increased in both the euro area and the United States, where they stood on an annualised basis at 21.5% and 21% respectively. These levels remain comparatively low from a historical perspective.

Yield spreads on bonds issued by euro area NFCs remained relatively insulated from tensions in sovereign debt and equity markets. Compared with mid-September, the spread on investment-grade NFC bonds relative to the risk-free rate fell by 3 basis points to 64 basis points. Spreads on financial sector debt with an investment-grade rating increased by 3 basis points to 93 basis points. Despite yield increases in the first half of 2018, corporate bond spreads remained significantly (50-60 basis points) below the levels observed in March 2016, prior to the announcement and subsequent launch of the corporate sector purchase programme.

The euro overnight index average (EONIA) ranged between -35 and -37 basis points over the period under review. Excess liquidity declined by around €37 billion to about €1,867 billion. This decline was driven by an increase in net autonomous factors, the maturity of the first series of targeted longer-term refinancing operations (TLTRO-I) and some early repayments of funds borrowed under the second series (TLTRO-II). At the same time, ongoing purchases under the Eurosystem’s asset purchase programme partially offset the decline in excess liquidity.

The EONIA forward curve shifted slightly upwards over the review period. Market participants revised up their interest rate expectations for longer horizons. The curve remains below zero for horizons prior to October 2020, reflecting market expectations of a prolonged period of negative interest rates.

In the foreign exchange markets, the euro depreciated in trade-weighted terms (see Chart 4). Over the period under review, the effective exchange rate of the euro, measured against the currencies of 38 of the euro area’s most important trading partners, weakened by 1.4%. In bilateral terms, the euro depreciated against the currencies of the major advanced economies, in particular the US dollar (by 2.0%), reflecting expectations about the evolution of monetary policy in the United States and the euro area, the Japanese yen (by1.0%) and the pound sterling (by 0.9%). The euro also depreciated vis-à-vis the currencies of most non-euro area EU Member States, as well as against the Chinese renminbi (by 0.6) and the currencies of other major emerging economies, such as Turkey, Russia and Brazil, which were supported by improving market sentiment following their previous significant depreciation. Over the same period, the euro strengthened vis-à-vis the Swiss franc by 1.0%.

Economic activity

Incoming information, while somewhat weaker than expected, remains overall consistent with ongoing broad-based economic expansion. Real GDP increased by 0.4%, quarter on quarter, in both the first and second quarters of the year, following the exceptionally strong dynamics observed in the previous five quarters (see Chart 5). Domestic demand made a positive contribution to the outcome in the second quarter, whereas net trade and changes in inventories had a neutral impact on GDP growth. Economic indicators, with survey results overall remaining at high levels, point to ongoing growth in the second half of the year.

In the second quarter employment rose further across euro area countries and sectors, increasing by 0.4% quarter on quarter. The average hours worked increased markedly in the second quarter, recovering from the decline due to the temporary impact of sick leave and strikes in the previous quarter.^[1] With the latest increase, employment stands 2.4% above the pre-crisis peak recorded in the first quarter of 2008. Since the trough recorded in the second quarter of 2013, cumulative employment growth in the euro area amounts to 9.2 million persons. The strong growth in employment seen during this period of economic expansion was accompanied by broadly unchanged average hours worked, which primarily reflects the impact of several structural factors (e.g. the large share of part‑time workers in total employment).

Looking ahead, short-term indicators point to continued strength in the labour market in the coming quarters. The euro area headline unemployment rate declined further to 8.1% in August (see Chart 6) – the lowest level seen since November 2008. Looking further ahead, survey indicators point to continued employment growth in the third quarter of the year.

Household income continued to support growth in private consumption. Private consumption rose by 0.2%, quarter on quarter, in the second quarter of 2018, following more dynamic growth in the previous quarter. This slowdown appears to reflect, on the one hand, adverse temporary factors (such as the impact of strikes on transport-related spending in France) and, on the other hand, the unwinding of positive temporary factors in the first quarter (higher energy consumption due to the cold winter). On an annual basis, consumption rose by 1.3% in the second quarter of 2018, which represents a slowdown from the first quarter, when consumption rose by 1.6%. At the same time, annual growth of households’ real disposable income increased from 1.7% in the first quarter to 1.9% in the second quarter. Thus, the slowdown in consumption growth was mirrored by a rise in the annual rate of change in savings – from 3.4% in the first quarter to 5.9% in the second quarter. The household saving ratio rose to 12.0% in the second quarter, slightly above the record low of 11.9% in the previous three quarters.

Private consumption is expected to display resilient growth in the coming quarters. Recent data on the volume of retail sales and new passenger car registrations point to ongoing growth in consumer spending in the third quarter of this year. However, it should be noted that the link between new passenger car registrations and car purchases, which feed into private consumption, is in all likelihood distorted at the current juncture, as it appears that a large part of the registrations in August were carried out by manufacturers/dealers rather than consumers. Other indicators also support the picture of continued robust consumption dynamics. For instance, households’ net worth continued to increase at robust rates in the second quarter, thus lending further support to private consumption. Moreover, the latest survey results signal further labour market improvements, which should continue to support aggregate income and thus consumer spending. In addition, although consumer confidence has declined in the course of 2018, it still stands at an elevated level and well above its long-term average.

Following the weak first quarter of 2018, investment growth rebounded in the second quarter. The quarterly 1.4% rise in investment in the second quarter of this year was brought about by an increase in investment in machinery, equipment and, to a lesser extent, intellectual property products (Box 2 provides an overview of developments in investment in intangible assets in the euro area). At the same time, quarterly growth in construction investment increased to 1.1%. By contrast, investment in transport equipment declined strongly in the same quarter. For the third quarter of 2018, short-term indicators point to continued growth. Monthly data on capital goods production in July and August stood, on average, 0.7% above their second quarter average, when they rose by 0.8% on a quarterly basis. On the other hand, indicators such as capacity utilisation (slightly declining but still high), confidence and orders (both lower) point to some downward risks to the growth momentum in non-construction investment. With regard to construction investment, monthly construction production data up to August point to continued – but moderating – growth in the third quarter of 2018.

Investment is expected to continue to grow solidly, supported by robust domestic demand and favourable financing conditions. According to the euro area sectoral accounts for the second quarter of 2018, business margins (measured as the ratio of net operating surplus to net value added) have remained broadly unchanged since the end of 2015 and continue to be close to long-term averages. However, uncertainties surrounding the future implementation of tariff increases may already be proving detrimental to investment decisions. As regards construction investment, households’ increasing intentions to buy or renovate, as well as constructors’ buoyant price and employment expectations, point to positive momentum in the construction sector over the short-term horizon. However, as financing conditions are expected to become slightly tighter, alternative long-term investment opportunities may gradually emerge.

Euro area trade growth remained moderate at the beginning of the third quarter of 2018. Based on information up to August, euro area nominal goods exports increased by 1.1% quarter on quarter, slightly below the figures registered in the second quarter of 2018 (1.3% quarter on quarter). In contrast, extra euro area goods exports rebounded in August (an increase of 2.1%, after a contraction of around 1.1% in July), suggesting some acceleration compared with the second quarter in quarter-on-quarter terms. Euro area nominal imports fell by 0.2%, month on month, in August, after increasing by 0.9% in July. Using information up to August, extra-euro area imports increased by 2.8% in nominal terms in the third quarter, reflecting an acceleration compared with the second quarter of 2018 (2.2% quarter on quarter). Survey indicators with leading properties, such as the Purchasing Managers’ Index (PMI) for new manufacturing export orders, and the European Commission’s assessment of export order book levels are consistent with a deterioration in export performance, showing a decline in October in the context of a downward trend since the beginning of the year. Hard data such as new manufacturing orders outside the euro area rebounded in August after some deterioration in June and July.

Overall, the latest economic indicators suggest ongoing broad–based growth. Industrial production (excluding construction) rebounded and recorded a relatively strong increase in August, following the sharp declines of the previous two months. Still, on average, production in July and August stood 0.2% below the level seen in the second quarter of 2018, when it rose by 0.1% on a quarterly basis. This weakness partly relates to temporary bottlenecks in the production of cars triggered by the testing process following the introduction of the Worldwide Harmonised Light Vehicle Test Procedure (WLTP) on 1 September. More timely survey data signal ongoing robust growth at rates similar to, or somewhat lower than, those recorded in the first half of the year. The composite output PMI averaged 54.3 in the third quarter, compared with 54.7 in the second quarter, before declining in October to 52.7. Meanwhile, the European Commission’s Economic Sentiment Indicator (ESI) eased to 112.5 in the third quarter, from 114.0 in the second quarter (see Chart 5). Both the PMI and the ESI continue to stand above their respective long-term averages.

The economic expansion is supported by domestic demand and continued improvements in the labour market. However, some recent sector-specific developments are having an impact on the near-term growth profile. The ECB’s monetary policy measures continue to underpin domestic demand. Private consumption is fostered by ongoing employment growth and rising wages. At the same time, business investment is supported by solid domestic demand, favourable financing conditions and corporate profitability. Housing investment remains robust. In addition, the expansion in global activity is expected to continue supporting euro area exports, although at a slower pace. The results of the latest round of the ECB Survey of Professional Forecasters, conducted in early October, show that private sector GDP growth forecasts were revised downwards for 2018 and 2019 compared with the previous round conducted in early July. The figure for 2020 remained unchanged.

The risks surrounding the euro area growth outlook are assessed as broadly balanced. At the same time, risks relating to protectionism, vulnerabilities in emerging markets and financial market volatility remain prominent.

Prices and costs

Euro area annual HICP inflation was 2.1% in September, up from 2.0% in August (see Chart 7). This increase reflected slightly higher contributions from food and energy price inflation, while the contributions of services and non-energy industrial goods price inflation were unchanged. Energy prices made a large contribution to headline inflation over recent months. The contribution varies significantly across euro area countries, due partly to differences in the degree of pass-through of oil prices to consumer energy prices (see the box entitled “The role of energy prices in recent inflation outcomes: a cross-country perspective” in this issue of the Economic Bulletin).

Measures of underlying inflation have remained generally muted but stand above earlier lows. HICP inflation excluding energy and food was 0.9% in September, the same as in August (revised down from an initial 1.0%). Over the same period, HICP inflation excluding energy, food and highly volatile components, such as travel-related items, clothing and footwear, was stable. Sideways developments over recent months were also highlighted by two model-based measures of underlying inflation, the Persistent and Common Component of Inflation indicator and the Supercore indicator. Nonetheless, each of the statistical and model-based measures remained higher than their respective lows in 2016.

Supply chain price pressures for non-energy industrial goods in the HICP continued to increase. The annual inflation rate for imported non-food consumer goods increased to -0.4% in July, up from its recent trough of -2.7% in April. Producer price inflation for domestic sales of non-food consumer goods increased from 0.5% in June to 0.6% in July and August.^[2] This was the highest outturn since late 2012, marking a continuation in the pick-up from the low of around 0.0% on average in 2016. Such resilience to downward pressure from the strong appreciation of the euro in 2017 may reflect the offsetting impact of strengthening domestic cost pressures. Price pressures remained strong in earlier stages of the supply chain; producer price inflation for intermediate goods was 3.2% in August, the same rate as in July.

Wage growth developments point to increasing domestic cost pressures. All the main sectors and most euro area countries contributed to the increase in annual growth in compensation per employee over recent quarters. This broad-based rise in wage growth, together with information on negotiated wage agreements covering the next one to two years, supports the expectation of a further pick-up. Overall, recent developments in wage growth have followed the direction of improving labour market conditions, as other factors that have weighed on wage growth – including past low inflation and the impact of labour market reforms implemented in some countries during the crisis – continue to fade.

Both market and survey-based measures of longer-term inflation expectations have remained stable (see Chart 8). On 24 October the five-year inflation-linked swap rate five years ahead stood at 1.67%. The forward profile of market-based measures of inflation expectations continues to point to a gradual return of inflation to levels below, but close to, 2%. The risk-neutral probability of deflation over the next five years implied by inflation options markets remains negligible. The results of the ECB Survey of Professional Forecasters (SPF) for the fourth quarter of 2018 show average headline inflation expectations of 1.7% for each of 2018, 2019 and 2020. This is unchanged from the profile in the previous survey. According to the SPF, average longer-term inflation expectations for the euro area continued to stay at 1.9%.

Residential property prices in the euro area continued to rise in the second quarter of 2018. According to the ECB’s residential property price indicator, prices for houses and flats in the euro area increased by 4.1% year on year in the second quarter of 2018, down from 4.3% in the first quarter of 2018, confirming a further consolidation of the house price cycle.

Money and credit

Broad money growth remained broadly stable in September. The annual growth rate of M3 interrupted the decline from its last peak (5.2%) in September 2017, increasing to 3.5% in September from 3.4% in August (see Chart 9) owing to a significant inflow into overnight deposits. Moreover, the reduction in net asset purchases (from €80 billion to €60 billion in April 2017, and then to €30 billion in January 2018) has meant that the asset purchase programme (APP) is having a smaller positive impact on M3 growth. The annual growth rate of M1, which includes the most liquid components of M3, again made a significant contribution to broad money growth and increased to 6.8% in September (up from 6.4% in August). Money growth continued to be bolstered by sustained economic expansion and the low opportunity cost of holding the most liquid instruments in an environment of very low interest rates.

Domestic sources of money creation remained the main driver of broad money growth. From a counterpart perspective, there was a further decline in the positive contribution to M3 growth from general government securities held by the Eurosystem (see the red parts of the bars in Chart 9), in the context of the aforementioned reduction in monthly net purchases under the APP. The decreasing contribution to M3 growth from the Eurosystem’s asset purchases has been offset by a moderate increase in the contribution from credit to the private sector since late 2017 (see the blue parts of the bars in Chart 9). By contrast, government bond sales by euro area MFIs excluding the Eurosystem dampened M3 growth (see the light green parts of the bars in Chart 9). Finally, the negative contribution from net external assets, which reflects both global uncertainty and investors’ preferences, moderated in September (see the yellow parts of the bars in Chart 9).

The growth of loans to the private sector strengthened further, continuing the upward trend observed since the beginning of 2014. The annual growth rate of MFI loans to the private sector (adjusted for loan sales, securitisation and notional cash pooling) was stable in September at 3.4% (see Chart 10). It benefitted from an increase in the annual growth rate of loans to non-financial corporations (NFCs), which reached 4.3% in September, up from 4.1% in August. At the same time, the annual growth rate of loans to households remained stable at 3.1%. While the annual growth rate of loans to households for house purchase remained moderate from a historical perspective, loan origination was strong. The recovery in loan growth has been supported by the significant decline in bank lending rates across the euro area since mid-2014 (notably owing to the ECB’s non-standard monetary policy measures) and by overall improvements in the supply of, and demand for, bank loans. In addition, banks have made progress in consolidating their balance sheets, although the volume of non-performing loans (NPLs) remains high in some countries and may constrain financial intermediation.^[3]

Loan growth continued to be supported by easing credit standards and increasing demand in the third quarter of 2018. According to the October 2018 euro area bank lending survey, the net easing of credit standards was driven mainly by competitive pressure and lower risk perceptions. Banks also reported increasing net loan demand across all loan categories, which is largely due to the low general level of interest rates, fixed investment, inventories and working capital, merger and acquisition (M&A) activity, favourable housing market prospects and consumer confidence. With regard to the APP, banks stated that it had improved their liquidity position and market financing conditions, but that it had negatively affected their profitability owing to the squeeze on net interest rate margins. The APP had an easing impact on credit terms and conditions across all loan categories. Moreover, it had a positive impact on banks’ lending volumes, but less than in the previous reporting period. Furthermore, the ECB’s negative deposit facility rate was said to be having a positive effect on lending volumes, while weighing on banks’ net interest income.

Very favourable lending rates continued to support euro area economic growth. In August 2018 the composite bank lending rate for loans to NFCs remained broadly stable at 1.65%, which is very close to its historical low seen in May of this year. The composite bank lending rate for housing loans remained stable in August at 1.81%, which is also close to its historical low from December 2016 (see Chart 11). Composite bank lending rates for loans to NFCs and households have fallen significantly and by more than market reference rates since the ECB’s credit easing measures were announced in June 2014. The reduction in bank lending rates on loans to NFCs, as well as on loans to small firms (assuming that very small loans of up to €0.25 million are granted mainly to small firms), was particularly significant in those euro area countries that were most exposed to the financial crisis. This indicates a more uniform transmission of monetary policy to bank lending rates across euro area countries and firm sizes.

Net issuance of debt securities by euro area NFCs declined in the first two months of the third quarter of 2018 compared with the equivalent months in the previous quarter. The latest ECB data indicate that, on a net basis, the total flow of debt securities issued by NFCs in July and August 2018 remained marginally positive and in line with the typical seasonal patterns observed over the last few years. From a more medium-term perspective (see Chart 12), the annual flows of debt securities continued to decline from the peaks reached around a year ago. Available market data suggest there was a considerable increase in the amount of debt securities issued over the period from September to October 2018. Total net issuance of quoted shares by NFCs was negative in July and August 2018, in line with the seasonal pattern of the series. Notwithstanding a slight decline in August relative to the previous month, annual flows remained close to the highest levels recorded since 2012.

Financing costs for euro area NFCs increased marginally in the first two months of the third quarter of 2018. The overall nominal cost of external financing for NFCs, comprising bank lending, debt issuance in the market and equity finance, rose to around 4.7% in August, up from 4.6% in June, and is projected to have remained at this level in September and October. Although the cost of financing is currently estimated to stand around 41 basis points above the historical low of August 2016, it is still considerably below the levels observed in the summer of 2014. The increase in the cost of financing since the end of the second quarter of 2018 reflects an increase in the cost of equity and, more recently, an increase in the cost of market-based debt. The cost of both short and long-term bank lending remained relatively stable over the same period.

Boxes

Purchases of green bonds under the Eurosystem’s asset purchase programme

Prepared by Roberto A. De Santis, Katja Hettler, Madelaine Roos and Fabio Tamburrini

This box analyses the impact of the Eurosystem’s asset purchase programme (APP) on the growing market for green bonds ^[4] . It describes the composition of the Eurosystem’s green bond holdings and assesses developments in prices and outstanding volumes of green bonds, before discussing the extent to which these may have been affected by the APP.

More

The geography of the euro area current account balance

Prepared by Michael Fidora and Martin Schmitz

The composition of the euro area current account balance in terms of its geographical counterparts has been fairly stable in recent years, with the euro area’s most important trading partners accounting for the largest part of the bilateral surpluses and deficits (see Chart A). Newly available data on the geographical breakdown of the euro area current account balance reveal that the largest share of the euro area’s external surplus of 3.5% of GDP in the year to the end of the second quarter of 2018 was accounted for by the United Kingdom and the United States, which contributed 1.4% and 1.0% of euro area GDP, respectively, followed by Switzerland (0.4% of euro area GDP). China, on the other hand, contributed negatively (about -0.6% of euro area GDP) to the current account balance of the euro area. At the same time, the impact of all other major trading partners for which a geographical breakdown is available was relatively limited, while a residual group of countries – including major oil producers – also contributed positively to the euro area’s external surplus (about 1.3% of euro area GDP).

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Investment in intangible assets in the euro area

Prepared by Malin Andersson and Lorena Saiz

Investment in intangible assets enables productivity gains. Intangible assets^[5] are non‐monetary assets without physical or financial substance. They encompass a broad range of highly heterogeneous assets, including human capital, innovative products, brands, patents, software, consumer relationships, databases and distribution systems. Some of these assets enable firms to obtain productivity gains and efficiencies from new technologies and, as such, play a strategic role in a firm’s value creation. This box reviews the characteristics of intangibles and looks at a number of implications of their increasing importance.

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Digitalisation and its impact on the economy: insights from a survey of large companies

Prepared by Catherine Elding and Richard Morris

This box summarises the findings of an ad hoc ECB survey of leading euro area companies looking at the impact that digitalisation has on the economy. ^[6] Digitalisation may be viewed as a technology/supply shock which affects the main economic aggregates, notably via competition, productivity and employment effects, as well as through its interaction with institutions and governance. Digital technologies are also changing the ways in which firms do business and interact with their customers and suppliers. Understanding digital transformation and the channels through which it influences the economy is therefore increasingly relevant for the conduct of monetary policy.

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The role of energy prices in recent inflation outcomes: a cross-country perspective

Prepared by Ieva Rubene

Euro area headline inflation is currently dominated by a strong contribution from energy prices. In the third quarter of 2018, energy prices contributed 0.9 percentage point to the headline HICP inflation rate of around 2.0%, thus accounting for almost half. This large contribution mainly reflects past developments in crude oil prices, a factor that constitutes a common influence across euro area countries. However, the contribution of energy to HICP inflation depends both on the share of energy in consumption expenditure and on the degree of pass-through of oil price developments to consumer energy prices. This box reviews the extent to which these features can help explain differences across euro area countries in the recent contribution of energy to overall HICP inflation.^[7]

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Articles

Potential output in the post-crisis period

Prepared by Malin Andersson, Bela Szörfi, Máté Tóth and Nico Zorell

Potential output is typically seen by economic analysts as the highest level of economic activity that can be sustained over the long term. Changes in potential output can be driven by factors such as labour supply, capital investment and technological innovation. Recent estimates by international institutions suggest that the euro area economy is currently operating close to its potential. The ongoing economic expansion appears to have largely absorbed the spare capacity created by the global financial crisis and the sovereign debt crisis. At the same time, the estimated rate of potential output growth also appears to have recovered most of its pre-crisis momentum, underpinned mainly by an expansion of the labour force, a decline in trend unemployment and stronger productivity gains. Looking ahead, projections by international institutions suggest that actual euro area GDP growth will continue to outpace potential growth in the near term. Hence, supply constraints are likely to become increasingly binding going forward, which would be conducive to a gradual strengthening of euro area inflation.

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The state of the housing market in the euro area

Prepared by Niccolò Battistini, Julien Le Roux, Moreno Roma and John Vourdas

The housing market has important macroeconomic and macroprudential implications for the euro area economy. In view of the duration of the ongoing upturn in euro area house prices and residential investment, which started at the end of 2013, analysing the state of the housing market is particularly informative. This article discusses the ongoing housing market upturn, from a chronological and fundamental perspective. It also explores a selected set of indicators that can potentially inform on the state of the housing market, elaborating on the demand and supply factors underpinning the current upturn, as well as their relative importance.

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Statistics

Statistical annex