Economic, financial and monetary developments

Overview

At its meeting on 12 September 2024, the Governing Council decided to lower the deposit facility rate – the rate through which it steers the monetary policy stance – by 25 basis points. Based on the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission, it was appropriate to take another step in moderating the degree of monetary policy restriction.

Recent inflation data have come in broadly as expected, and the September 2024 ECB staff macroeconomic projections confirm the previous inflation outlook. ECB staff see headline inflation averaging 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026, as in the June 2024 Eurosystem staff macroeconomic projections. Inflation is expected to rise again in the latter part of this year, partly because previous sharp falls in energy prices will drop out of the annual rates. Inflation should then decline towards the Governing Council’s target over the second half of next year. For core inflation, the projections for 2024 and 2025 have been revised up slightly, as services inflation has been higher than expected. At the same time, ECB staff continue to expect a rapid decline in core inflation, from 2.9% this year to 2.3% in 2025 and 2.0% in 2026.

Domestic inflation remains high as wages are still rising at an elevated pace. However, labour cost pressures are moderating, and profits are partially buffering the impact of higher wages on inflation. Financing conditions remain restrictive, and economic activity is still subdued, reflecting weak private consumption and investment. ECB staff project that the economy will grow by 0.8% in 2024, rising to 1.3% in 2025 and 1.5% in 2026. This is a slight downward revision compared with the June projections, mainly owing to a weaker contribution from domestic demand over the next few quarters.

The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim. The Governing Council will continue to follow a data-dependent and meeting-by-meeting 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. The Governing Council is not pre-committing to a particular rate path.

Economic activity

The economy grew by 0.2% in the second quarter, after 0.3% in the first quarter, falling short of the June 2024 Eurosystem staff macroeconomic projections. Growth stemmed mainly from net exports and government spending. Private domestic demand weakened, as households consumed less, firms cut business investment and housing investment dropped. While services supported growth, industry and construction contributed negatively. According to survey indicators, the recovery is continuing to face some headwinds.

The labour market remains resilient. The unemployment rate was broadly unchanged in July, at 6.4%. At the same time, employment growth slowed to 0.2% in the second quarter, from 0.3% in the first. Recent survey indicators point to a further moderation in demand for labour, and the job vacancy rate has fallen closer to pre-pandemic levels.

The latest indicators suggest growth will continue in the short run but at rates lower than expected in the June 2024 Eurosystem staff macroeconomic projections. Real disposable income should continue to increase, supported by robust wage growth. This, together with gradually increasing confidence, would underpin a consumption-driven recovery. However, the impulse from consumption is somewhat weaker than foreseen in the June projections, with incoming data and recent surveys pointing to still subdued consumer confidence and elevated household saving intentions. Recent data on business investment also suggest weaker growth momentum. Domestic demand will nevertheless be supported by past monetary policy tightening effects wearing off and an assumed continued easing of financing conditions, in line with market expectations of the future path of interest rates. In addition, a projected rise in foreign demand supports the outlook for euro area exports. The labour market is seen as remaining resilient, with the unemployment rate expected to stay at historically low levels. As some of the cyclical factors that have lowered productivity growth in the recent past unwind, productivity is expected to pick up over the projection horizon. Overall, annual average real GDP growth is expected to be 0.8% in 2024 and to reach 1.3% in 2025 and 1.5% in 2026. Compared with the June 2024 Eurosystem staff macroeconomic projections, the outlook for GDP growth has been revised marginally down for each year of the projection horizon.

Fiscal and structural policies should be aimed at making the economy more productive and competitive, which would help to raise potential growth and reduce price pressures in the medium term. Mario Draghi’s report on the future of European competitiveness and Enrico Letta’s report on empowering the Single Market stress the urgent need for reform and provide concrete proposals to make this happen. Implementing the EU’s revised economic governance framework fully, transparently and without delay will help governments bring down budget deficits and debt ratios on a sustained basis. Governments should now make a strong start in this direction in their medium-term plans for fiscal and structural policies.

Inflation

According to Eurostat’s flash estimate, annual inflation dropped to 2.2% in August, from 2.6% in July. Energy prices fell at an annual rate of 3.0%, after an increase of 1.2% in the previous month. Food price inflation went up slightly, to 2.4% in August. Goods inflation and services inflation moved in opposite directions. Goods inflation declined to 0.4%, from 0.7% in July, while services inflation rose, to 4.2% from 4.0%.

Most measures of underlying inflation were broadly unchanged in July. Domestic inflation edged down only slightly, to 4.4% from 4.5% in June, with strong price pressures coming especially from wages. Negotiated wage growth will remain high and volatile over the remainder of the year, given the significant role of one-off payments in some countries and the staggered nature of wage adjustments. At the same time, the overall growth in labour costs is moderating. The growth in compensation per employee fell further to 4.3% in the second quarter, the fourth consecutive decline, and ECB staff project it to slow markedly again next year. Despite weak productivity, unit labour costs grew less strongly in the second quarter, by 4.6%, after 5.2% in the first quarter. ECB staff expect unit labour cost growth to continue declining over the projection horizon owing to lower wage growth and a recovery in productivity. Finally, profits are continuing to partially offset the inflationary effects of higher labour costs.

The disinflation process should be supported by receding labour cost pressures and the past monetary policy tightening gradually feeding through to consumer prices. Most measures of longer-term inflation expectations stand at around 2%, and the market-based measures have fallen closer to that level since the Governing Council’s meeting on 18 July 2024.

Following its recent moderation, headline inflation is projected to increase somewhat in the last quarter of this year, before declining further to the inflation target by the end of 2025. The expected increase in the near term largely reflects energy base effects. Over the medium term, energy inflation should settle at low positive rates given market expectations for energy commodity and wholesale prices and planned climate change-related fiscal measures. Recent quarters have seen food price inflation decline strongly, as pipeline pressures have been easing due to lower energy and food commodity prices. Food price inflation is expected to move broadly sideways before moderating further from the end of 2025 onwards. Inflation excluding energy and food is expected to remain above headline inflation for almost all of the projection horizon, but to continue its disinflationary path. Services inflation has remained stubbornly high over recent months. However, a gradual decline is still expected later in the horizon, with wage growth and other cost pressures easing, while the lagged impact of past monetary policy tightening continues to feed through to consumer prices. In recent quarters, nominal wage growth has started to decline from elevated levels and by more than previously projected. A further gradual easing of wage growth is expected over the coming years as upward impacts from inflation compensation pressures in a tight labour market continue to fade. A recovery in productivity growth should support the moderation in labour cost pressures. Moreover, profit growth has declined notably and will partially buffer the pass-through of labour costs to prices, especially in the near term. Overall, in the September 2024 ECB staff macroeconomic projections, annual average headline inflation is expected to decrease from 5.4% in 2023 to 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026. Compared with the June 2024 Eurosystem staff macroeconomic projections, the outlook for headline inflation remains unchanged. Inflation excluding energy and food has surprised slightly on the upside in recent months, leading to small upward revisions for 2024 and 2025.

Risk assessment

The risks to economic growth remain tilted to the downside. Lower demand for euro area exports, owing for instance to a weaker world economy or an escalation in trade tensions between major economies, would weigh on euro area growth. Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East are major sources of geopolitical risk. This may result in firms and households becoming less confident about the future and global trade being disrupted. Growth could also be lower if the lagged effects of monetary policy tightening turn out stronger than expected. Growth could be higher if inflation comes down more quickly than expected and rising confidence and real incomes mean that spending increases by more than anticipated, or if the world economy grows more strongly than expected.

Inflation could turn out higher than anticipated if wages or profits increase by more than expected. Upside risks to inflation also stem from the heightened geopolitical tensions, which could push energy prices and freight costs higher in the near term and disrupt global trade. Moreover, extreme weather events, and the unfolding climate crisis more broadly, could drive up food prices. By contrast, inflation may surprise on the downside if monetary policy dampens demand more than expected, or if the economic environment in the rest of the world worsens unexpectedly.

Financial and monetary conditions

Market interest rates have declined markedly since the Governing Council’s meeting on 18 July 2024, mostly owing to a weaker outlook for global growth and reduced concerns about inflation pressures. Tensions in global markets over the summer led to a temporary tightening of financial conditions in the riskier market segments.

Overall, financing costs remain restrictive as the Governing Council’s past policy rate increases continue to work their way through the transmission chain. The average interest rates on new loans to firms and on new mortgages stayed high in July, at 5.1% and 3.8% respectively.

Credit growth remains sluggish amid weak demand. Bank lending to firms grew at an annual rate of 0.6% in July, down slightly from June, and growth in loans to households edged up to 0.5%. Broad money – as measured by M3 – grew by 2.3% in July, the same rate as in June.

Monetary policy decisions

At its meeting on 12 September 2024, the Governing Council decided to lower the deposit facility rate by 25 basis points. The deposit facility rate is the rate through which the Governing Council steers the monetary policy stance. In addition, as pre-announced on 13 March 2024 following the operational framework review, the spread between the interest rate on the main refinancing operations and the deposit facility rate was set at 15 basis points. The spread between the rate on the marginal lending facility and the rate on the main refinancing operations remained unchanged at 25 basis points. Accordingly, the deposit facility rate was decreased to 3.50%. The interest rates on the main refinancing operations and the marginal lending facility were decreased to 3.65% and 3.90% respectively. The changes took effect from 18 September 2024.

The asset purchase programme portfolio is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.

The Eurosystem no longer reinvests all of the principal payments from maturing securities purchased under the pandemic emergency purchase programme (PEPP), reducing the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.

The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.

As banks are repaying the amounts borrowed under the targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted lending operations and their ongoing repayment are contributing to its monetary policy stance.

Conclusion

The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim. The Governing Council will continue to follow a data-dependent and meeting-by-meeting 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. The Governing Council is not pre-committing to a particular rate path.

In any case, the Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its medium-term target and to preserve the smooth functioning of monetary policy transmission.

1 External environment

Global growth was resilient in the second quarter of 2024 and is projected to remain steady in the third quarter. However, incoming data suggest that manufacturing is slowing while monetary policy is still restrictive. These signals, coupled with elevated geopolitical tensions and volatility in financial markets, suggest that headwinds to growth may intensify in the near term. The outlook for global growth and inflation, as reflected in the September 2024 ECB staff macroeconomic projections for the euro area, is broadly unchanged compared with the June 2024 Eurosystem staff macroeconomic projections. Global trade is projected to recover this year and grow more in line with global activity thereafter. For 2024 global trade was revised up slightly to reflect stronger outturns in the second quarter, but the near-term outlook embedded in the September projections suggests that the strong growth seen in the second quarter will not be sustained. Inflation across major advanced and emerging market economies is expected to gradually decline over the projection horizon.

Global growth momentum remains positive, but headwinds may intensify in the near term. The global (excluding the euro area) composite output Purchasing Managers’ Index (PMI) ticked up to 53.2 in August from 53.0 in July. This was supported by above-average levels of the services sector output index, whereas manufacturing sector output declined to just above the neutral threshold (Chart 1).^[1] This fall reflected a pronounced slowing of manufacturing activity in the United States in August, whereas manufacturing output in China improved marginally in August after a strong decline in the previous month. Incoming hard and soft data suggest that the global manufacturing cycle is slowing amid still-restrictive monetary policies and moderating wage growth. These signals, coupled with elevated geopolitical tensions and recent volatility in global financial markets, suggest that headwinds to global growth may intensify in the near term. Global GDP is estimated to have increased by 0.7% in the second quarter, somewhat below the pace recorded in the first quarter. Nevertheless, it was still in line with the June Eurosystem staff projections and is expected to remain steady in the third quarter.

Chart 1

Global PMI output

(diffusion indices)

Global growth is projected to expand at a moderate pace, broadly unchanged compared with the June projections. After expanding by 3.5% in 2023, global real GDP is projected to grow by 3.4% in both 2024 and 2025 and 3.3% in 2026. This mild slowdown in growth over the projection horizon reflects the impact of fading tailwinds to consumer spending in an environment of a still-restrictive monetary policy stance in the first years of the projection horizon, heightened geopolitical tensions and elevated economic policy uncertainty. Compared with the June projections, global real GDP growth has been revised up by 0.1 percentage points over the projection horizon. This reflects somewhat stronger growth in emerging markets in 2024 and higher growth in the US economy in 2025-26. The latter is linked to the positive impact of net migration being higher than previously assumed and the assumption that the 2017 tax cuts for lower income households will be extended, as this features in the electoral platforms of both presidential candidates.

Global trade growth increased strongly in the second quarter, amid frontloading of goods imports in advanced economies. Global imports jumped by 1.9% quarter on quarter in the second quarter, more than three times the pace recorded at the beginning of this year and well above the June projections. This strong growth was supported by a frontloading of imports from China and other emerging Asian countries in advanced economies. Monthly trade data indicate that companies restocked for the Christmas season about six weeks earlier than in a typical year, likely reflecting fears over renewed supply bottlenecks and trade tensions against a background of rising geopolitical risks. While global trade data remain inherently volatile, the September projections suggest that such strong growth will not be sustained in the near term as the impact of frontloading fades.^[2] This is in line with signals from the ECB’s nowcasting tool, which embeds hard and soft data on global trade (Chart 2). More specifically, weak export orders indicated by PMI surveys, as well as estimates for trade turnover based on vessel movements, point towards a slowdown in trade in the third quarter. Nonetheless, a normalising inventory cycle and a more favourable composition of demand should still support trade developments towards the end of the year.

Chart 2

World imports

(quarterly percentage changes)

Global trade is projected to recover this year and to grow more in line with global activity over the rest of the projection horizon. Following a period of weak growth dynamics, amid the post-pandemic rebalancing of demand from goods to services, global trade rebounded at the turn of the year, with the frontloading of imports in advanced economies in the second quarter adding to this recovery. Overall, global import growth is projected to total 3.1% this year, which is 0.5 percentage points above the June projections. This mainly reflects stronger momentum in the second quarter, whereas quarterly growth in the second half of 2024 is set to remain unchanged. Global import growth is projected to increase to 3.4% in 2025 and 3.3% in 2026.

Incoming data suggest that the gradual disinflation will resume, notwithstanding a slight increase in inflation observed in July. Headline consumer price index (CPI) inflation across the member countries of the Organisation for Economic Co-operation and Development (OECD) stood at 3.0% in July, up from 2.8% in June.^[3] Core inflation (excluding energy and food) also increased slightly in July, to 3.2%, up from 3.1% in June. The declining momentum in headline CPI inflation, measured as a three-month-on-three-month annualised percentage change, indicates that disinflation across OECD countries will resume in the near term (Chart 3), supported by the ongoing cooling of labour markets across major economies.

Chart 3

OECD headline CPI inflation momentum

(three-month-on-three-month annualised percentage change, percentage point contributions)

Oil prices have decreased since the last Governing Council meeting, while European gas prices have increased. Brent crude oil prices have fallen by almost 10% compared with the levels observed at the time of the last Governing Council meeting. This is due to a combination of factors including, on the demand side, the drop in crude oil imports into China to their lowest levels in years owing to weak economic activity. A negative risk sentiment in the wake of the market sell-off in early August also contributed to lower crude oil prices, whereas supply-side news related to tensions in the Middle East and outages in Libyan oil fields were pushing crude oil prices up. European gas prices increased by 17.7% in response to geopolitical concerns. These include escalating tensions in the Middle East and the incursion of Ukrainian troops into Russian territory. The latter gave rise to investor fears over potential supply disruptions on the Ukrainian transit route for gas.

In the United States, economic activity is still robust amid an ongoing adjustment in the labour market and gradually declining inflation. Real GDP increased by 0.7% in the second quarter, supported by strong domestic demand and inventories which more than offset the drag from a large increase in imports. Robust consumption spending supported activity. High-frequency indicators point to sustained, albeit slightly declining growth in the near term, with no signs of an imminent recession. Market fears of a potential recession were heightened in August following the July US employment report, and the subsequent volatility in global financial markets which has since subsided. Both ECB staff nowcasts and those published by regional Federal Reserve Banks point to a slight deceleration in growth in the third quarter, which is consistent with the delayed effects of the Federal Reserve’s restrictive monetary policy on economic activity. The US labour market has continued to soften but remained healthy overall. An increase in non-farm employment in August was slightly below market expectations and the average monthly gain over the prior 12 months. At the same time, the unemployment rate declined marginally to 4.2%, while the participation rate held steady. Annual headline CPI inflation declined slightly more than expected in August, to 2.5%, down from 2.9% in July. This was the smallest increase in annual headline inflation since March 2021. By contrast, annual core CPI inflation stood at 3.2% in August, unchanged compared with July.

Economic activity is slowing in China, while new real estate support has yet to stabilise the housing market. Real GDP growth declined markedly in the second quarter, to 0.7% from 1.5% in the first quarter, as the property downturn acted as a drag on consumer spending and the impulse from a late 2023 stimulus programme faded. July activity data were mostly weak, despite some positive signals in some manufacturing sectors and in exports. Retail sales growth was subdued, while industrial production slowed further. In addition, fixed asset investment remained anaemic, as property investment contracted, despite relatively strong manufacturing and infrastructure investment. Exports remained the most important driver of growth, buoyed by declining export prices. Annual growth in nominal exports was still robust in July, despite moderating more than expected. Chinese producers recorded sizeable gains in export volumes across all major product categories, as falling export prices helped their competitiveness. The property market still shows no signs of bottoming out yet and thus remains a drag on growth, while the new policy package announced in mid-May and earlier measures have yet to have an effect. Given the rather disappointing growth outlook, the Chinese authorities have become increasingly concerned about missing their growth target of “around 5%” and on 30 July, the Politburo of the Chinese Communist Party called for more policy measures to support consumption. Chinese headline CPI inflation picked up slightly in August, while both core consumer price inflation and producer price inflation declined further. Sluggish domestic demand, mainly in private consumption and driven by headwinds in the property market and weak industrial prices, suggests that inflationary pressures in the Chinese economy will remain subdued.

In the United Kingdom, real GDP growth increased strongly in the second quarter, while inflation ticked up. Real GDP rose by 0.6% in the second quarter of 2024, only slightly below the 0.7% recorded in the first quarter. After a shallow technical recession last year, the UK economy witnessed a surprisingly robust rebound in the first half of this year, driven by domestic demand. Imports, particularly from emerging markets, expanded at a strong pace, possibly reflecting a frontloading that is also apparent at the global scale. Growth momentum is expected to moderate in the second half of this year. Despite the current strength in activity, growth is projected to fall in the face of continued restrictive fiscal and monetary policies. The new Labour government has committed itself to observing long-standing fiscal rules, which limits the scope it has to stimulate demand. On the monetary side, real rates have increased substantially as inflation has come down to close to the Bank of England’s target in recent months. Despite these headwinds, some upside risks are emerging from the ongoing resilience among households and businesses. With the saving ratio still climbing and real wages expanding, underpinned by robust payroll growth and only small increases in unemployment, UK households might have room to increase their spending despite restrictive policies. Headline CPI inflation increased to 2.2% in July from 2.0% in both May and June. This increase was expected and reflected the unwinding of negative base effects from energy prices. Core CPI inflation (excluding energy and food) decreased from 3.5% in June to 3.3% in July on the back of a fall in services inflation. This moderation in services inflation was larger than expected by both the markets and the Bank of England and partly reflects a gradual unwinding of second-round effects from high energy prices. However, upside risks to the disinflation process remain, as services inflation has been stickier than anticipated this year. The Bank of England started a data-dependent easing cycle in July by cutting its policy rate from 5.25% to 5.0%.

2 Economic activity

The economy grew by 0.2% in the second quarter, after 0.3% in the first quarter, falling short of the June 2024 Eurosystem staff macroeconomic projections for the euro area. Net trade contributed positively to growth in the second quarter, while domestic demand contracted. Incoming information points to continued, albeit slow, growth in the third quarter of 2024. Business survey results have somewhat weakened, exacerbated by softer sentiment in the labour market. Across sectors, services continue to lead the recovery, having received a significant boost from the Paris Olympics in the third quarter. At the same time, the industrial sector shows continued weakness, both in output and orders, in a context of high uncertainty. Looking ahead, real GDP is expected to continue to recover, as real incomes increase further, foreign demand strengthens and the dampening effects of tight monetary policy fade. The continued rise in real disposable income is expected to support private consumption, which should become the main driver of growth from the second half of 2024 onwards. The still resilient labour market, coupled with gradually increasing consumer confidence and declining uncertainty, should also support household spending.

This outlook is broadly reflected in the September 2024 ECB staff macroeconomic projections for the euro area, which foresee annual real GDP growth of 0.8% in 2024, picking up to 1.3% and 1.5% in 2025 and 2026 respectively.^[4]

According to Eurostat’s latest estimate, real GDP increased by 0.2%, quarter on quarter, in the second quarter of 2024, having expanded by 0.3% in the previous quarter (Chart 4). Net trade contributed positively to growth in the second quarter, while domestic demand contributed negatively and the contribution from changes in inventories was neutral. The improvement in total value added was entirely driven by services, with falls in industry and construction.

Chart 4

Euro area real GDP and its components

(quarter-on-quarter percentage changes; percentage point contributions)

Survey data point to a continued services-led expansion in the third quarter of 2024. The composite output Purchasing Managers’ Index (PMI) stood at 50.6 on average in July and August, down from 51.6 in the second quarter of 2024. The index, which continues to indicate growth, has thus held up since the start of its upward movement in October 2023, despite having eased recently. Across sectors, the PMI indicator for manufacturing output remained in contractionary territory throughout July and August, discontinuing the upward movement that started in the summer of 2023 (Chart 5, panel a). The new orders index, which should be more forward looking, has shown a similar pattern. Overall, these indicators suggest continued weakness in the industrial sector going forward, amid subdued demand for goods and the impact of the past tightening of monetary policy. PMI data for the services sector, which has so far led the recovery in activity, continue to point to positive growth in both activity and new business (Chart 5, panel b). Services have also benefited from the boost in spending in contact-intensive services from the Paris Olympics. Developments in the PMI suggest that the recent sectoral divergence is likely to persist in the short term.

Chart 5

PMI indicators across sectors of the economy

a) Manufacturing	b) Services
(diffusion indices)	(diffusion indices)

Employment growth slowed in the second quarter of 2024. Employment rose by 0.2% in the second quarter of the year (Chart 6, panel a) owing mainly to the continued, albeit slowing, expansion of the labour force. Productivity per employee and average hours worked remained stable in the second quarter of 2024. The unemployment rate declined marginally to 6.4% in July, from 6.5% in June, driven by the lower number of unemployed and slowing growth in the labour force. Labour demand has declined somewhat from the high levels seen after the pandemic, with the job vacancy rate falling to 2.6% in the second quarter, 0.3 percentage points lower than in the previous quarter and closer to its pre-pandemic peak.

Chart 6

Euro area employment, PMI assessment of employment and unemployment rate, and sectoral employment PMIs

a) Employment, PMI assessment of employment and unemployment rate

(left-hand scale: quarter-on-quarter percentage changes, diffusion index; right-hand scale: percentages of the labour force)

b) Sectoral employment PMIs

(diffusion indices)

Short-term labour market indicators point to only marginal employment growth in the third quarter of 2024. The monthly composite PMI employment indicator remained broadly unchanged at 49.9 in August, slightly down from 50.1 in July, suggesting that employment growth is likely to slow further (Chart 6, panel b). The PMI services indicator decreased from 51.3 in July to 50.9 in August. By contrast, the PMI manufacturing and construction indicators increased slightly but remained in contractionary territory.

Private consumption weakened in the second quarter of 2024 but is expected to strengthen. Private consumption declined marginally in the second quarter of 2024, having shown weak average growth in the previous quarters. This muted growth path stands in contrast with the marked improvement in households’ purchasing power since late 2023, reflecting lower inflation and rising labour and non-labour income (Chart 7, panel a). The rise in income has supported an increase in household savings, which appear to also reflect the tighter financing conditions (with elevated interest rates and still high consumer credit standards) and weak borrowing, as well as a reduced need to use savings buffers in the context of a resilient labour market. In addition, uncertainty still prevails and consumer confidence remains subdued (see Box 3). Incoming survey data suggest household spending will increase in the near term. The European Commission’s indicators of business expectations for demand in contact-intensive services and retail trade expectations for the next three months improved in August – remaining above and drawing closer to their pre-pandemic averages respectively (Chart 7, panel b). Consumer expectations for major purchases in the next twelve months, which rose above their pre-pandemic level in July and remained close to that level in August, also indicate strengthening consumer demand. Similarly, the ECB’s latest Consumer Expectations Survey showed an increasing propensity to spend on major items over the next twelve months, while expected holiday purchases remained at a high level.

Chart 7

Decomposition of private consumption growth and expectations for contact-intensive services, retail trade and major purchases

a) Decomposition of private consumption growth

(quarter-on-quarter percentage changes; percentage point contributions)

b) Expectations

(standardised percentage balances)

Business investment grew modestly in the second quarter of 2024 but is likely to grow less in the second half of the year. Non-construction investment excluding Irish intangibles rose by 0.7% in the second quarter of 2024 (and fell by 3.7% including Irish intangibles). Short-term indicators available up to August suggest further weakness in the capital goods sector in the third quarter (Chart 8, panel a): PMI output has moved broadly sideways this year and the European Commission’s confidence indicator has edged up from a low level in recent months. Forward-looking indicators for the sector, such as the August PMI new orders indicator, fell. Investment is expected to be held back by weak demand in the near term, amid a decline in capacity utilisation and still elevated uncertainty. According to the Commission’s survey for the third quarter of 2024 published in July, demand is providing less support for production in the capital goods sector than in the past. Commission survey data – reflecting falling capacity utilisation and the perception that space and equipment considerations are limiting production in the economy to a diminishing extent – indicate that the immediate need to expand investment has also eased. Investment plans may also be delayed by elevated uncertainty, as well as geopolitical risks. Business investment is expected to continue to grow in the medium term, driven by the projected rise in demand, the fading impact of tight financing conditions and large green and digital investment needs.

Chart 8

Real investment dynamics and survey data

a) Business investment	b) Housing investment
(quarter-on-quarter percentage changes; percentage balances and diffusion indices)	(quarter-on-quarter percentage changes; percentage balances and diffusion index)

Housing investment fell significantly in the second quarter of 2024 and is expected to continue to decline in the short term, albeit at a slower pace. Housing investment in the euro area fell by 1.3% in the second quarter of 2024, while production in building and specialised construction edged down by 0.2%. Survey-based activity indicators point to a further decline in housing investment in the third quarter of 2024, with both the PMI indicator for housing production and the European Commission’s indicator for building and specialised construction activity in the last three months remaining in contractionary territory up to August (Chart 8, panel b). However, the decline in housing investment is likely to slow. According to the Commission’s survey, the short-term intention of households to renovate and buy or build a house has improved further in the third quarter of 2024. At the same time, the ECB’s Consumer Expectations Survey shows that the proportion of households that consider housing as a good investment continued to increase in July, amid stabilising interest rate expectations. Moreover, in the July bank lending survey, banks expected a further increase in demand for housing loans in the third quarter of this year. All of this points to a gradual improvement in housing demand, which should eventually lead housing investment to bottom out.

Euro area export growth softened markedly in the second quarter of 2024. After rising in the first quarter, euro area export growth slowed to 0.1%, quarter on quarter, in the second quarter of 2024 (excluding Ireland, owing to the high level of data volatility). This deceleration underlines the ongoing competitiveness challenges facing euro area exporters, even amid a recovery in global demand. By contrast, services exports continued to bolster overall export performance, driven by robust demand for travel, business and ICT services. Looking ahead, the latest PMIs for export orders suggest that export performance will remain subdued in the near term. At the same time, the earlier recovery in euro area import growth appears to be losing momentum. Import growth stagnated in the second quarter (and was at zero when excluding Ireland), as euro area manufacturers cut back on input purchases in response to weaker demand. This decline was largely the result of weaker exports of goods. Net exports made a positive contribution of 0.5% to GDP in the second quarter, reflecting the stronger performance of exports over imports. However, with import prices stabilising, the improvement in the terms of trade is now stalling.

The euro area economy is expected to continue to recover in the medium term, largely on the back of strengthening private consumption. Looking ahead, real GDP is expected to recover as real incomes increase further, foreign demand strengthens and the dampening effects of tight monetary policy fade. The continued rise in real disposable income is expected to support private consumption, which should become the main driver of growth from the second half of 2024 onwards. The resilient labour market, coupled with gradually increasing consumer confidence and declining uncertainty, should also support household spending. Business investment is projected to improve later on, mostly reflecting the waning, but still present, drag from past monetary policy tightening and supported by both domestic and foreign demand.

The September 2024 ECB staff macroeconomic projections for the euro area foresee annual real GDP growth of 0.8% in 2024, 1.3% in 2025 and 1.5% in 2026. This is a slight downward revision compared with the June projections (-0.1 percentage points for all years), mainly owing to a weaker contribution from domestic demand over the next few quarters.

3 Prices and costs

Euro area headline inflation dropped to 2.2% in August 2024 from 2.6% in July, primarily reflecting a decline in energy inflation. Most measures of underlying inflation were broadly unchanged in July, with strong price pressures stemming from wages in particular. However, the overall rate of growth in labour costs is moderating, with profits in part buffering the impact of continued elevated labour cost pressures on inflation. This supports the ongoing disinflation. Over the review period, measures of longer-term inflation expectations remained broadly stable, with most measures standing at around 2%, and market-based measures falling closer to this level. The September 2024 ECB staff macroeconomic projections for the euro area foresee that headline inflation will decline gradually from 2.5% in 2024, to 2.2% in 2025 and 1.9% in 2026.^[5]

Euro area headline inflation, measured in terms of the Harmonised Index of Consumer Prices (HICP), fell to 2.2% in August 2024 from 2.6% in July (Chart 9)^[6]. This decrease resulted from lower inflation rates for energy and non-energy industrial goods (NEIG), which more than offset higher inflation rates for food and services. The annual rate of change in energy inflation dropped substantially, from 1.2% in July 2024 to -3.0% in August. This decline was driven by a downward base effect, owing to a significant increase in energy prices in August 2023. Food inflation rose slightly to 2.4% in August 2024, from 2.3% in July, reflecting a higher annual rate of change in unprocessed food prices, while the annual rate of change in processed food prices remained unchanged. HICP inflation excluding energy and food (HICPX) decreased to 2.8% in August, after standing at 2.9% in July, owing to a fall in NEIG inflation (0.4% in August, down from 0.7% in July), thus outweighing the increase in services inflation (4.2% in August, up from 4.0% in July). The meanwhile largely normalised growth rates for NEIG reflect diminishing earlier pipeline price pressures, while the more persistent services inflation is linked to the stronger role of labour costs in some of its items and lagged repricing in others.

Chart 9

Headline inflation and its main components

(annual percentage changes; percentage point contributions)

Most underlying inflation indicators were stable in July, albeit standing at different levels (Chart 10). In July 2024 (latest available data), the indicator values ranged from 1.8% to 4.4%. The Persistent and Common Component of Inflation (PCCI) indicator is constructed to identify the common component of inflation across a comprehensive set of price movements and is currently the best barometer for medium-term inflation during the post-pandemic period. The PCCI indicator lies at the bottom of this range, while the domestic inflation indicator (which excludes HICP items with a large import content) lies at the top. The Supercore indicator, which comprises HICP items that are sensitive to the business cycle, and which stood at 2.9% in July, was unchanged from the previous month. HICPXX inflation (which refers to HICPX inflation excluding travel-related items, clothing and footwear) also remained unchanged at 2.7% in July, whereas the PCCI indicator increased slightly to 1.8% in July, from 1.7% in June. The indicator for domestic inflation fell slightly to 4.4% in July, but continued to stand at a persistently high level, reflecting the strong weight of services items such as insurance, recreation and accommodation services.

Chart 10

Indicators of underlying inflation

(annual percentage changes)

Pipeline pressures remained moderate, albeit they now show signs of edging up from low levels (Chart 11). At the early stages of the pricing chain, producer price inflation for energy, which had been negative since March 2023, edged up to ‑6.9% in July 2024, from -9.6% in June. The annual growth rate of producer prices for domestic sales of intermediate goods also remained negative, albeit less so than in the previous month (-1.2% in July, up from -2.3% in June). The corresponding annual growth rate of import prices stood at zero in July, after standing at -1.3% in June. At the later stages of the pricing chain, domestic producer price inflation for non-food consumer goods was unchanged at 0.9% in July, and the same applied to the manufacturing of food products, which remained at 0.1%. Import price pressures for consumer goods edged upwards in July, partly reflecting the fact that the year-on-year rate of change in the nominal effective exchange rate of the euro had turned broadly neutral following an earlier increase. Overall, pipeline pressures broadly stabilised and now show signs of edging up from low levels, suggesting that the easing of pipeline pressures following earlier cost shocks has faded out.

Chart 11

Indicators of pipeline pressures

(annual percentage changes)

Domestic cost pressures, as measured by growth in the GDP deflator, further decreased in the second quarter of 2024, albeit remaining elevated overall (Chart 12). The annual growth rate of the GDP deflator dropped to 3.0% in the second quarter of 2024, down from 3.6% in the previous quarter. This decline reflected smaller contributions from all of the main components, but with the largest downward impact stemming from unit labour costs. The reduced impact from unit labour costs was the result of a decline in wage growth, measured in terms of compensation per employee, which fell from 4.8% in the first quarter of 2024 to 4.3% in the second quarter. Wage growth measured in terms of compensation per hour also decreased, to 4.2% in the second quarter of 2024 from 5.0% in the first quarter. Negotiated wage growth declined to 3.5% in the second quarter of 2024, from 4.7% in the first quarter, but with data on the latest wage agreements in the ECB’s forward-looking wage tracker pointing to stronger growth in negotiated wages in the third quarter of 2024.^[7] Overall, however, the latest wage developments point to a decreasing role of compensation for past high inflation and the corresponding real wage catch-up.^[8] Annual growth in compensation per employee for 2024 is projected to stand at 4.5%, on average, and is expected to continue to moderate over the projection horizon, albeit remaining above historical levels owing to continuing tight labour markets and remaining inflation compensation.

Chart 12

Breakdown of the GDP deflator

(annual percentage changes; percentage point contributions)

Survey-based indicators of longer-term inflation expectations remained broadly unchanged with most standing at around 2%, and market-based measures falling closer to this level over the review period (Chart 13). In both the ECB Survey of Professional Forecasters for the third quarter of 2024 and the September 2024 ECB Survey of Monetary Analysts, average and median longer-term inflation expectations (for 2029) stood at 2.0%. Market-based measures of inflation compensation (based on the HICP excluding tobacco) at the longer end of the yield curve declined by around 27 basis points, with the five-year forward inflation-linked swap rate five years ahead standing at around 2.1%. At the same time, it should be noted that these market-based measures of inflation compensation are not a direct gauge of the genuine inflation expectations of market participants, as these measures include inflation risk premia. Model-based estimates of genuine inflation expectations, excluding inflation risk premia, indicate that market participants continue to expect inflation to hover around 2% in the longer term. Market-based measures of near-term euro area inflation outcomes also dropped significantly, which suggests that investors expect inflation to fall further and to stand at around 2% for the remainder of this year, before settling below 2% in the subsequent year. The revisions to market participants expectations can be partly attributed to lower global energy prices, notably oil prices, but also to concerns about economic growth in the United States. Specifically, over the review period, the one-year forward inflation-linked swap rate one year ahead fell by 47 basis points and currently stands at 1.7%. On the consumer side, inflation expectations appear to have levelled off in recent months. According to the ECB’s Consumer Expectations Survey for July 2024, the median expectations for headline inflation over the next year remained unchanged at 2.8% (for the third consecutive month), while the expectations for three years ahead edged up to 2.4%, from 2.3% in June. Perceptions of past inflation declined in July 2024 but remain above the inflation expectations at the one-year and three-year horizons.

Chart 13

Market-based measures of inflation compensation and consumer inflation expectations

a) Market-based measures of inflation compensation

(annual percentage changes)

b) Headline inflation and ECB Consumer Expectations Survey

(annual percentage changes)

The September 2024 ECB staff macroeconomic projections expect headline inflation to average 2.5% in 2024 and to decline further to 2.2% in 2025 and 1.9% in 2026 (Chart 14). Headline inflation is projected to increase slightly in the last quarter of 2024, mainly owing to base effects in energy prices, before returning to a downward path. The overall decline in 2024 reflects the continued waning of pipeline pressures as well as the impact of monetary policy tightening. A gradual easing is expected to continue over the coming years, as upward impacts from wage growth and inflation compensation pressures in a tight labour market continue to fade. Compared with the June 2024 projections, the projections for headline inflation remained unchanged. For HICPX inflation, the projections for 2024 and 2025 have been revised up slightly, by 0.1 percentage points, compared with the June 2024 projections due to higher-than-expected inflation in services. At the same time, ECB staff continue to expect a rapid decline in core inflation, from 2.9% in 2024 to 2.3% in 2025 and 2.0% in 2026.

Chart 14

Euro area HICP and HICPX inflation

(annual percentage changes)

4 Financial market developments

During the review period from 6 June to 11 September 2024, a general reappraisal of the outlook for economic growth and inflation pushed risk-free interest rates down in major advanced economies. In the euro area, forward rates fell across all maturities, with market participants anticipating faster and deeper cumulative policy rate cuts. Specifically, at the end of the review period forward rates entailed around 60 basis points of cumulative interest rate cuts by the end of the year, with markets fully pricing in the rate cut of 25 basis points at the September Governing Council meeting. Euro area long-term risk-free nominal interest rates have also declined, primarily reflecting the fall in inflation compensation, with long-term real rates having edged down too. Sovereign bond yields also recorded a decline, albeit to a lesser extent than risk-free rates, with some volatility around the snap elections in France and the sell-off in global equity markets in early August. Prices of risky assets experienced substantial volatility over the review period. In early August, equity prices recorded significant losses, amid deteriorating risk appetite and weak global macroeconomic data releases. Despite regaining much of the ground lost in early August, stock prices of euro area companies are still below the levels recorded in June, owing to downgraded earnings expectations and higher risk premia. In foreign exchange markets, the euro appreciated somewhat against the US dollar but remained broadly stable in trade-weighted terms.

Since the June Governing Council meeting the overnight index swap (OIS) forward curve has shifted downwards as market participants expect faster and deeper cumulative policy rate cuts (Chart 15). The benchmark euro short-term rate (€STR) averaged 3.7% over the review period, following the Governing Council’s widely anticipated decision at its June meeting to lower the key ECB interest rates by 25 basis points. Excess liquidity decreased by around €130 billion from 6 June to 11 September, to stand at €3,072 billion. This mainly reflected repayments in June of funds borrowed in the third series of targeted longer-term refinancing operations (TLTRO III) and the decline in the portfolios of securities held for monetary policy purposes, as the Eurosystem no longer reinvests the principal payments from maturing securities in the asset purchase programme (APP) portfolio and only partially reinvests principal payments in the pandemic emergency purchase programme (PEPP) portfolio. The €STR-based OIS forward curve has shifted downwards since the June Governing Council meeting, amid significant declines in market-based measures of inflation compensation and weak global macroeconomic data releases. It fully priced in a rate cut of 25 basis points at the September Governing Council meeting. Overall, the forward curve has moved from pricing in (on June 6) around 35 basis points of cumulative interest rate cuts in the course of 2024, to pricing in (on 11 September) around 60 basis points of cumulative cuts.

Chart 15

€STR forward rates

(percentages per annum)

Euro area long-term risk-free rates have also declined since the June Governing Council meeting, albeit by less than their US counterparts (Chart 16). The ten-year euro OIS rate declined by 41 basis points and ended the review period at around 2.2%. This decline in long-term nominal risk-free rates reflected the fall in the inflation component, partly resulting from euro area macroeconomic data releases and elevated global risks, but primarily resulting from US data releases – which led to even larger declines in US long-term interest rates. Specifically, US long-term risk-free rates fluctuated more significantly and declined more noticeably during the review period, particularly on days of macroeconomic data releases. In particular, the ten-year US Treasury yield decreased by 63 basis points to 3.7%. As a result, the differential between long-term risk-free rates in the euro area and the United States has narrowed by approximately 20 basis points. The ten-year UK sovereign bond yield declined by 42 basis points to 3.8%.

Chart 16

Ten-year sovereign bond yields and the ten-year OIS rate based on the €STR

(percentages per annum)

Euro area sovereign bond yields have also declined, albeit to a lesser extent than risk-free rates, resulting in somewhat wider spreads (Chart 17). At the end of the review period, the ten-year GDP-weighted euro area sovereign bond yield stood about 37 basis points lower, at around 2.7%, leading to an increase of 4 basis points in its spread over the OIS rate based on the €STR. More notable increases were observed for the French ten-year sovereign spread versus the ten-year OIS yield which widened markedly following the announcement on 9 June of snap parliamentary elections in France, but subsequently narrowed somewhat again. Overall, the French sovereign spread widened by 17 basis points in the review period. Widening of sovereign spreads was also observed for Greece, Spain, Italy, and Portugal, notably around the French snap elections and the global sell-off in equity markets in early August. However, by the end of the review period, with the exception of France, euro area sovereign spreads had broadly returned to the levels observed at the beginning of the period.

Chart 17

Ten-year euro area sovereign bond spreads vis-à-vis the ten-year OIS rate based on the €STR

(percentage points)

Spreads of corporate bonds edged up for investment-grade firms and widened significantly for high-yield firms. Spreads of investment-grade corporate bonds fluctuated moderately and stood 14 basis points higher at the end of the review period. In contrast, spreads in the high-yield segment widened by 57 basis points, driven by developments in bond spreads of both financial and non-financial corporations (NFCs), which widened by 33 and 64 basis points respectively.

Despite partially recovering from significant losses recorded in early August, euro area equity prices ended the review period lower, dragged down by worsening risk sentiment and weak macroeconomic data releases around the globe (Chart 18). Euro area equity prices experienced substantial volatility over the review period. They first weakened around the snap elections in France, affecting particularly French corporations and curbing the previously buoyant risk appetite. Then they recorded significant losses in early August as weak macroeconomic data releases triggered fears of a recession in the United States and led to a sharp drop in global risk appetite. Although equity prices on both sides of the Atlantic have regained much of the ground lost in early August, stock prices of euro area companies have underperformed US stock prices. Dragged down by lower earnings expectations and higher risk premia, broad stock market indices in the euro area weakened by 5% over the review period, albeit with some divergence across sectors. The equity prices of NFCs declined by 8%, while bank equity prices declined by 4%. In the United States, the overall equity price index increased over the review period, with both NFC and bank equity prices strengthening by around 3%.

Chart 18

Euro area and US equity price indices

(index: 1 January 2020 = 100)

In foreign exchange markets, the euro appreciated by 1% against the US dollar but remained broadly stable in trade-weighted terms (Chart 19). During the review period, the nominal effective exchange rate of the euro – as measured against the currencies of 41 of the euro area’s most important trading partners – depreciated by 0.2%. The appreciation of the euro against the US dollar (1%) was largely driven by a downward repricing of market participants’ expectations regarding the path of the Federal Reserve System’s policy rate in early August amid signs that the US labour market was cooling. Moreover, the euro appreciated by 0.5% against the pound sterling. The euro also appreciated against some emerging market currencies. By contrast, the euro depreciated markedly against the Japanese yen (-8.5%) and the Swiss franc (-3.5%) following the unwinding of carry trades funded by the latter two currencies during the episode of heightened financial market volatility in early August.

Chart 19

Changes in the exchange rate of the euro vis-à-vis selected currencies

(percentage changes)

5 Financing conditions and credit developments

Financing costs have remained restrictive. In July 2024 composite euro area bank funding costs and bank lending rates remained at tight levels. Growth rates for bank loans to firms and to households continued to be subdued, reflecting high lending rates, weak economic growth and tight credit standards. Over the period from 6 June to 11 September 2024, the cost to firms of market-based debt declined significantly, owing to a fall in risk-free interest rates, while the cost of equity financing increased. The annual growth rate of broad money (M3) showed signs of stabilisation at low levels, net foreign inflows continuing to be the main contributor to growth.

Euro area bank funding costs have remained high. The composite debt financing cost for euro area banks has remained stable at high levels since January 2024 and saw no change in July (Chart 20, panel a). High bank funding costs have persisted, owing to the ongoing recomposition of funding towards more expensive sources, such as time deposits – remunerated at a higher rate than overnight deposits – and bank bond issuance, in a context of gradual phasing out of targeted longer-term refinancing operations (TLTROs) funding. Interest rates on time deposits and, to a lesser extent, on overnight deposits declined between May and June and were unchanged in July. Rates on deposits redeemable at notice remained broadly constant. Bank bond yields declined against the backdrop of the policy rate cut in June and the repricing of the risk-free rate curve, even though some volatility in bond markets in the course of the Summer prevented a larger adjustment in market-based funding costs (Chart 20, panel b).

Chart 20

Composite bank funding costs in selected euro area countries

(annual percentages)

Bank lending rates for firms and households edged down slightly in July compared with May, while still standing at levels close to the peaks of the past twelve years. In July lending rates for non-financial corporations (NFCs) remained broadly unchanged at 5.06%, after a marginal decline in June (Chart 21, panel a), amid heterogeneity across euro area countries and maturities. Lending rates on new loans to households for house purchase declined slightly to 3.75% in July, following four months of broad stability at around 3.80% (Chart 21, panel b), although some degree of cross-country heterogeneity was observed.

Chart 21

Composite bank lending rates for firms and households in selected countries

(annual percentages)

Over the period from 6 June to 11 September 2024, the cost to firms of market-based debt fell significantly owing to a decline in risk-free interest rates, while their cost of equity financing increased. Based on the available monthly data, the overall cost of financing for NFCs – i.e. the composite cost of bank borrowing, market-based debt and equity – stood at 6.2% in July, slightly lower than the level recorded in June and below the multi-year high reached in October 2023 (Chart 22).^[9] This was the result of a reduction in all components of NFC financing costs, with the exception of the cost of short-term bank loans, which remained virtually unchanged. Daily data covering the period from 6 June to 11 September 2024 confirm a fall in the cost of market-based debt, owing to a marked decline in the risk-free interest rate – as approximated by the ten-year overnight index swap rate – that was only partially offset by a small widening of the spreads on bonds issued by NFCs, especially in the high-yield segments. Notwithstanding the decline in the risk-free interest rate, the cost of equity financing increased over the same period, driven by a rising equity risk premium.

Chart 22

Nominal cost of external financing for euro area firms, broken down by component

(annual percentages)

External financing flows of firms and borrowing by households remained muted, reflecting high lending rates, weak economic growth and tight credit standards. In July, the annual growth rate of bank lending to firms decreased to 0.6%, down slightly from 0.7% in June (Chart 23). While short-term bank lending flows for firms remain volatile, lending at longer maturities has been slowing, with almost no growth, this being consistent with weak investment. The issuance of debt securities by firms was also close to nil overall from May to July, amid volatility. The annual growth rate of household lending edged up to 0.5% in July, from 0.3% in June, remaining sluggish. These subdued figures reflected weak lending for house purchases (0.5% annual growth in July) and lending for other purposes (contracting by 2.7% in annual terms in July). Consumer credit growth was, however, more resilient (recording 2.8% annual growth in July). The ECB’s Consumer Expectations Survey in July 2024 confirmed a still large net percentage of survey respondents reporting that credit access had become harder over the previous 12 months and expecting it to become even more difficult over the next 12 months.

Chart 23

MFI loans in selected euro area countries

(annual percentage changes)

The annual growth rate of broad money (M3) in the euro area showed signs of stabilisation at low levels, net foreign inflows continuing to be the main contributor to growth.^[10] M3 growth remained unchanged at 2.3% in July, amid volatility in monthly flows (Chart 24). Annual growth of narrow money (M1) – which comprises the most liquid assets of M3 – stayed in negative territory but continued to increase, rising to -3.1% in July compared with -3.4% in June. Likewise, the annual growth rate of overnight deposits rose to -3.6% in July, up from -4.0% in June. Foreign inflows remained the only consistent positive driver of money growth, amid subdued lending to households and firms, the continuing contraction of the Eurosystem balance sheet and the issuance of long-term bank bonds (which are not included in M3) in a context of ongoing repayments of TLTRO funds.

Chart 24

M3, M1 and overnight deposits

(annual percentage changes, adjusted for seasonal and calendar effects)

6 Fiscal developments

According to the September 2024 ECB staff macroeconomic projections, the euro area general government budget deficit is expected to decline from 3.6% of GDP in 2023 to 3.3% of GDP in 2024 and then further to 3.2% in 2025 and 3.0% in 2026. The euro area fiscal stance is projected to tighten significantly in 2024, and to tighten further – albeit by less – over the following two years. The tightening in 2024 mostly reflects the phasing-out of a large part of energy-related and inflation-related support measures. In 2025 and 2026, the continued tightening is due to a further scaling down of the remaining energy support measures, increases in direct taxes and social security contributions, and slower growth in fiscal transfers. Governments will soon release their medium-term fiscal-structural plans for the first time under the EU’s revised economic governance framework. Implementing the revised framework fully, transparently and without delay will help governments bring down budget deficits and debt ratios on a sustained basis. Governments should now make a strong start in this direction in their medium-term plans.

According to the September 2024 ECB staff macroeconomic projections, the euro area general government budget balance will improve moderately over the projection horizon (Chart 25).^[11] While the euro area budget deficit was stable at 3.6% of GDP in 2022 and 2023, it should decline gradually over the projection horizon to 3.3% of GDP in 2024 and then further to 3.2% in 2025 and 3.0% in 2026. The projected path reflects mainly a gradually shrinking but still negative cyclically adjusted primary balance over the projection horizon, with most of the reduction occurring in 2024 as the bulk of the remaining energy and inflation support measures are phased out. This impact will, however, be partly compensated by gradually increasing interest expenditures over the whole period, reflecting a slow pass-through of past interest rate increases given long residual maturities of outstanding sovereign debt.

Chart 25

Budget balance and its components

(percentages of GDP)

Compared with the June 2024 Eurosystem staff macroeconomic projections, the budget deficit is projected to be moderately higher over the whole projection horizon. This more adverse outlook is driven by enhanced discretionary fiscal policies, as consolidation plans in some countries now seem less likely to fully materialise. In addition, negative composition effects from the updated macroeconomic projections contribute to higher primary deficits reflecting downward revisions in tax-rich bases, such as compensation of employees and nominal private consumption. As a result, the budget balance as a percentage of GDP has been revised down by 0.2 percentage points in 2024 and by a further 0.4 and 0.5 percentage points in 2025 and 2026 respectively.

The euro area fiscal stance is still projected to tighten significantly in 2024 and somewhat further over the following two years.^[12] The annual change in the cyclically adjusted primary balance, adjusted for grants extended to countries under the NGEU programme, points to a significant tightening (0.5 percentage points of GDP) of fiscal policies in the euro area in 2024. This mostly reflects the phasing-out of a large part of governments’ energy and inflation-related support measures. The fiscal stance is projected to continue tightening – although at a much slower pace – in 2025 and 2026, owing to a further scaling down of the remaining energy support measures, combined with increases in direct taxes and social security contributions, and slower growth in fiscal transfers. These tightening factors are expected to be only partly compensated by increases in government consumption and investment. As a result, the cumulated tightening of the fiscal stance over the 2024-26 projection horizon amounts to 0.9 percentage points of GDP.

The euro area debt-to-GDP ratio is projected to increase slowly from an already elevated level (Chart 26). The debt ratio increased significantly during the pandemic, to around 97% in 2020, although it then fell gradually. This improvement seems to have come to a halt, however. The debt ratio is now expected to increase slowly from about 88% of GDP in 2023 to close to 90% of GDP by the end of the projection horizon, driven by continued primary deficits and expected positive deficit-debt adjustments that are only partly compensated by shrinking but still negative interest rate-growth differentials.

Chart 26

Drivers of change in euro area government debt

(percentages of GDP, unless otherwise indicated)

Implementing the EU’s revised economic governance framework fully, transparently and without delay will help governments bring down budget deficits and debt ratios on a sustained basis. As a first step in the implementation phase of the new governance framework, Member States were required to submit their medium-term fiscal-structural plans for the first time to the European Commission by 20 September. However, several countries have signalled delays to 15 October to align with the submission of draft budgetary plans for 2025. Governments should now make a strong start in this direction in their medium-term plans. At the euro area level, a consolidation of public finances, designed in a growth-friendly manner, will be necessary over the coming years.

Boxes

1 Labour productivity growth in the euro area and the United States: short and long-term developments

Prepared by António Dias da Silva, Paola Di Casola, Ramon Gomez-Salvador and Matthias Mohr

Between the fourth quarter of 2019 and the second quarter of 2024 labour productivity per hour worked increased by 0.9% in the euro area, whereas it increased by 6.7% in the United States. Labour productivity growth in the euro area has historically lagged behind that in the United States, but the developments in the euro area since the start of the pandemic have been particularly weak. Productivity growth started diverging in the second quarter of 2020, as total labour input as a share of GDP decreased more strongly in the United States than in the euro area, leading to a more significant rebound in productivity (Chart A). This was due in part to the implementation of job retention schemes in the euro area while unemployment was surging in the United States. After briefly narrowing, the gap in productivity growth started widening again after mid-2022, when euro area productivity growth was depressed following the large energy price shock. In this box, we address the role of sectoral productivity and historical developments in explaining the recent gap in overall productivity growth between the two regions. This gap reflects both cyclical and structural factors.

2 Accounting for nature in euro area economic activity

Prepared by Mariana Martins Cardoso and Miles Parker

Nature contributes a range of critical services to economic production, many of which are insufficiently accounted for in standard economic statistics. Generally referred to as “ecosystem services”, these inputs include crucial functions such as pollination, air and water filtration, carbon sequestration, and the provision of crops, timber and other resources. The value of these services is rarely directly measured in statistics like GDP. For example, the price of food implicitly includes the economic value of natural pollination, but in the absence of direct measurement, that value is attributed to the agricultural sector.

3 Why are euro area households still gloomy and what are the implications for private consumption?

Prepared by Alina Bobasu, Dario Esposito and Johannes Gareis

Consumer confidence in the euro area plummeted when Russia launched its full-scale invasion of Ukraine and has remained at a low level since then, despite some recovery. Consumer confidence has gradually improved from its post-invasion low of September 2022. However, it has not yet returned to its pre-pandemic average and was well below its pre-invasion levels as of August 2024 (Chart A). This box analyses the underlying factors that explain this subdued consumer confidence and assesses the implications of persistently low confidence for private consumption in the short run.

4 Findings from a survey of leading firms on labour market trends and the adoption of generative AI

Agostino Consolo, Guzman Gonzalez-Torres Fernandez, Richard Morris and Christofer Schroeder

A recent ECB survey asked leading non-financial companies about the drivers of some key characteristics of the euro area labour market in recent years. These characteristics include an increased tendency for firms to cite recruitment difficulties; high and growing employment despite stagnating economic activity (and hence reduced labour productivity); a notable fall in average hours worked; and an increase in remote working. This part of the survey included a set of general statements with which respondents could agree, agree strongly, disagree, disagree strongly, or neither agree nor disagree. Respondents were asked to take a medium-term perspective, comparing the current environment with that of five to ten years ago. If they agreed or strongly agreed with a general statement, they were also asked to reply to a set of sub-statements exploring the reasons why.

5 Recent developments in wages and the role of wage drift

Prepared by Colm Bates, Katalin Bodnár and Kathinka Schlieker

Monitoring wages is a key element in the ECB’s approach to analysing the inflation outlook. This reflects the prominent role of wages in the dynamics of underlying inflation, in particular in the services component, which has remained persistent. The outlook for further disinflation in the September 2024 ECB staff macroeconomic projections is predicated inter alia on the expectation of moderating wage growth.

6 Liquidity conditions and monetary policy operations from 17 April to 23 July 2024

Prepared by Samuel Bieber and Christian Lizarazo

This box describes liquidity conditions and the Eurosystem monetary policy operations during the third and fourth reserve maintenance periods of 2024. Together, these two maintenance periods ran from 17 April to 23 July 2024 (the “review period”).

7 Money and credit dynamics in the euro area and a comparison with the United States

Prepared by Ramón Adalid, Lucía Kazarian, Davide Malacrino and Silvia Scopel

This box examines the recent transmission of monetary policy to money and credit volumes and interest rates in the euro area and compares it with that in the United States, highlighting key differences and similarities during the pandemic period. First, interest rates on deposits have reached higher levels in the euro area than in the United States (the US), despite a smaller increase in the policy rate and a lower starting point. Second, since the start of monetary policy tightening, credit growth has declined more sharply in the euro area, possibly owing to stronger demand and more abundant deposits in the US. Third, the moderation in US broad money growth from its pandemic peak appears much greater, as asset purchases by the US Federal Reserve System (the Fed) during the pandemic were almost double those by the Eurosystem, expressed in terms of GDP.

Articles

1 Past and future challenges for the external competitiveness of the euro area

Prepared by Michael Fidora and Vanessa Gunnella

Euro area exporters have been going through a difficult period since the pandemic and have lost competitiveness in global trade. Over the past two decades, the euro area has experienced a gradual decline in its market share in global trade. This downward trend is not unique to the euro area: other advanced economies have also been losing market shares as emerging economies become more integrated in global trade. While decreasing market shares do not necessarily reflect a decrease in competitiveness, the decline in the euro area’s role in trade has accelerated more sharply than in other regions since the pandemic, suggesting that the euro area is facing particular challenges to its external competitiveness.

2 Economic and financial impacts of nature degradation and biodiversity loss

Prepared by Andrej Ceglar, Miles Parker, Carlo Pasqua, Simone Boldrini, Marie Gabet and Sjoerd van der Zwaag

Nature is crucial to human wellbeing and provides essential ecosystem services that support economic activity. Nature encompasses all living and non-living elements on our planet, forming ecosystems such as forests, lakes and wetlands.^[13] These ecosystems provide habitats for numerous species and tangible goods like food, freshwater, timber and medicinal resources. These also maintain environmental balance, for example by regulating air quality, controlling climate and mitigating floods. Key processes facilitated by ecosystems include soil formation, nutrient cycling and pollination. Nature also offers intangible benefits such as recreation and tourism. These benefits are greatly at risk from the current unprecedented rate of nature degradation and biodiversity loss.

Statistics