Economic and monetary developments

Overview

Based on a thorough assessment of the economic and inflation outlook for the euro area, also taking into account the latest staff macroeconomic projections, the Governing Council took a number of decisions at its monetary policy meeting on 12 September in pursuit of its price stability objective. Incoming information since the last Governing Council meeting indicates a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures. This is reflected in the September staff projections, which show a further downgrade of the inflation outlook. At the same time, robust employment growth and increasing wages continue to underpin the resilience of the euro area economy. Against this overall backdrop, the Governing Council announced a comprehensive package of monetary policy measures in response to the continued shortfall of inflation with respect to its aim (see Box 1).

Economic and monetary assessment at the time of the Governing Council meeting of 12 September 2019

Global growth softened in the first half of 2019, reflecting decelerating economic activity in both advanced and emerging economies. This is in line with survey-based indicators which point to subdued global activity. Global growth is projected to decline this year amid weak global manufacturing activity on the back of declining global investment and rising policy and political uncertainty on account of Brexit and the renewed intensification of trade tensions between the United States and China. Looking ahead, global growth is projected to gradually recover over the medium term but to remain below its long-term average. Global trade is expected to further weaken significantly this year but to recover in the medium term, while remaining more subdued than economic activity. Global inflationary pressures are expected to remain contained, while downside risks to global economic activity have intensified.

Global long-term risk-free rates have declined since the Governing Council meeting in June 2019 amid market expectations of further accommodative monetary policy and a resurgence of global trade uncertainty. This decline in risk-free rates has supported the prices of euro area equities and corporate bonds. Meanwhile, corporate earnings expectations have fallen somewhat in response to persistent doubts about the global macroeconomic outlook. The EONIA forward curve also shifted downwards. In foreign exchange markets, the euro remained broadly unchanged in trade-weighted terms.

Euro area real GDP increased by 0.2%, quarter on quarter, in the second quarter of 2019, following a rise of 0.4% in the previous quarter. Incoming economic data and survey information continue to point to moderate but positive growth in the third quarter of this year. This slowdown in growth mainly reflects the prevailing weakness of international trade in an environment of prolonged global uncertainties, which are particularly affecting the euro area manufacturing sector. At the same time, the services and construction sectors are showing ongoing resilience and the euro area expansion is also supported by favourable financing conditions, further employment gains and rising wages, the mildly expansionary euro area fiscal stance and the ongoing – albeit somewhat slower – growth in global activity.

This assessment is broadly reflected in the September 2019 ECB staff macroeconomic projections for the euro area. These projections foresee annual real GDP increasing by 1.1% in 2019, 1.2% in 2020 and 1.4% in 2021. Compared with the June 2019 Eurosystem staff macroeconomic projections, the outlook for real GDP growth has been revised down for 2019 and 2020. The risks surrounding the euro area growth outlook remain tilted to the downside. These risks mainly pertain to the prolonged presence of uncertainties related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.0% in August 2019, which is unchanged from July. Lower energy inflation was offset by higher food inflation, while the rate of HICP inflation excluding food and energy was unchanged. On the basis of current futures prices for oil, headline inflation is likely to decline before rising again towards the end of the year. Measures of underlying inflation remained generally muted and indicators of inflation expectations stand at low levels. While labour cost pressures strengthened and broadened amid high levels of capacity utilisation and tightening labour markets, their pass-through to inflation is taking longer than previously anticipated. Over the medium term, underlying inflation is expected to increase, supported by the ECB’s monetary policy measures, the ongoing economic expansion and robust wage growth.

This assessment is also broadly reflected in the September 2019 ECB staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.2% in 2019, 1.0% in 2020 and 1.5% in 2021. Compared with the June 2019 Eurosystem staff macroeconomic projections, the outlook for HICP inflation has been revised down over the whole projection horizon, reflecting lower energy prices and the weaker growth environment. Annual HICP inflation excluding energy and food is expected to be 1.1% in 2019, 1.2% in 2020 and 1.5% in 2021.

The annual growth of broad money increased markedly in July 2019, while loans to the private sector remained broadly unchanged. Broad money (M3) growth increased to 5.2% in July 2019, after 4.5% in June. Sustained rates of broad money growth reflect ongoing bank credit creation for the private sector and low opportunity costs of holding M3. Furthermore, M3 growth remained resilient in the face of the fading out of the mechanical contribution of the net purchases under the asset purchase programme (APP) and weakening economic momentum. At the same time, favourable bank funding and lending conditions continued to support loan flows and thereby economic growth. The annual growth rate of loans to non-financial corporations remained unchanged at 3.9% in July 2019. The monetary policy measures decided by the Governing Council, including the more accommodative terms of the new series of quarterly targeted longer-term refinancing operations (TLTRO III), will help to safeguard favourable bank lending conditions and will continue to support access to financing, in particular for small and medium-sized enterprises.

The aggregate fiscal stance for the euro area is projected to be mildly expansionary, providing some support to economic activity. In the next two years, the stance will continue to be mildly expansionary, mainly on account of further cuts in direct taxes and social security contributions in most of the larger euro area countries. In view of the weakening economic outlook and the continued prominence of downside risks, governments with fiscal space should act in an effective and timely manner. In countries where public debt is high, governments need to pursue prudent policies that will create the conditions for automatic stabilisers to operate freely.

Monetary policy decisions

Based on the regular economic and monetary analyses, the Governing Council made the following decisions:

• First, the interest rate on the deposit facility was decreased by 10 basis points to ‑0.50%. The interest rate on the main refinancing operations and the rate on the marginal lending facility were kept unchanged at their current levels of 0.00% and 0.25% respectively. The Governing Council now expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.
• Second, net purchases will be restarted under the APP at a monthly pace of €20 billion as from 1 November. The Governing Council expects the APP to run for as long as necessary to reinforce the accommodative impact of the ECB’s policy rates, and to end shortly before it starts raising the key ECB interest rates.
• Third, reinvestments of the principal payments from maturing securities purchased under the APP will continue, in full, for an extended period of time past the date when the Governing Council starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.
• Fourth, the Governing Council decided to change the modalities of TLTRO III to preserve favourable bank lending conditions, ensure the smooth transmission of monetary policy and further support the accommodative stance of monetary policy. The interest rate in each operation will now be set at the level of the average rate applied in the Eurosystem’s main refinancing operations over the life of the respective TLTRO. For banks whose eligible net lending exceeds a benchmark, the rate applied in TLTRO III operations will be lower, and can be as low as the average interest rate on the deposit facility prevailing over the life of the operation. The maturity of the operations will be extended from two to three years.
• Fifth, in order to support the bank-based transmission of monetary policy, the Governing Council decided to introduce a two-tier system for reserve remuneration in which part of banks’ holdings of excess liquidity will be exempt from the negative deposit facility rate.

The Governing Council took these decisions in response to the continued shortfall of inflation with respect to its aim. With this comprehensive package of monetary policy decisions, the ECB is providing substantial monetary stimulus to ensure that financial conditions remain very favourable and support the euro area expansion, the ongoing build-up of domestic price pressures and, thus, the sustained convergence of inflation to the Governing Council’s medium-term inflation aim. The Governing Council reiterated the need for a highly accommodative stance of monetary policy for a prolonged period of time. Looking ahead, it continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry.

External environment

Global growth softened in the first half of 2019, reflecting decelerating economic activity in both advanced and emerging economies. This is in line with survey-based indicators which point to subdued global activity. Activity in services, although weakening, continued to support growth while growth momentum in global manufacturing remains subdued. Global growth is projected to decrease this year amid weak global manufacturing activity on the back of declining global investment and rising policy and political uncertainty on account of Brexit and the renewed intensification of trade tensions between the United States and China. While those headwinds are expected to weigh on global activity and trade this year and next, recent policy measures are expected to provide some support. As a result, global growth is projected to stabilise over the medium term, albeit at a level below the average growth rate observed before the crisis. Global trade is expected to weaken significantly this year but recover in the medium term, while remaining more subdued than economic activity. Global inflationary pressures are expected to remain contained, while downside risks to global economic activity have intensified.

Global economic activity and trade

Global growth softened in the first half of 2019. In the first quarter, real GDP growth held up relatively well in most advanced economies owing to temporary factors in some countries (e.g. positive contributions from net trade and a build-up of inventories in the United States and stock-building in advance of the first Brexit deadline in the United Kingdom). In the second quarter, as the impact of such factors unwound, growth moderated. In the United States, as imports stabilised, the negative contribution of net trade weighed on growth in spite of the fiscal stimulus and resilient private consumption. In the United Kingdom, growth turned negative in the second quarter on account of, among other things, a slowdown in investment. While activity in China remained stable in the first half of the year amid resilient private consumption, growth stumbled in several other emerging market economies (EMEs) in the first quarter, reflecting adverse idiosyncratic factors in some countries (a dam disaster in Brazil and contamination of an oil pipeline in Russia) and more persistent headwinds, such as elevated domestic political uncertainty (in Mexico and Brazil). Growth ticked up in the second quarter as some of these headwinds dissipated and economic activity continued to grow in some other countries (e.g. in Turkey, owing to strong private consumption and a positive net trade contribution).

Survey-based indicators continue to point to subdued global activity. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area decelerated further in the second quarter of 2019 and, after a small rebound in July, declined again in August. The deceleration in the first half of the year was broad-based across advanced and emerging economies, though more recently a small uptick has been recorded in the composite PMI indicator for EMEs. Global activity in the services sector, which had been more resilient overall at the turn of the year, also deteriorated in the second quarter and declined still further in August, but remains above the 50 threshold. Global manufacturing activity has been on a declining trend for the past year. After falling into “contraction” territory in June and July (i.e. below the 50 threshold), it rebounded above the neutral mark in August (see Chart 1).

Global financial conditions have experienced some volatility in recent months. Since the finalisation of the June 2019 Eurosystem staff macroeconomic projections, risky asset prices have experienced some volatility amid conflicting signals. On the one hand, hopes of a bilateral trade deal between the United States and China and the expectation of a more accommodative monetary policy on both sides of the Atlantic led to a rebound in asset prices in June and July. With investors anticipating rate cuts, US Treasury yields and other safe government bond yields moved significantly lower and, at the same time, financial conditions in EMEs eased significantly. On the other hand, the renewed escalation of the US‑China trade dispute in early August and the indication from the Federal Open Market Committee (FOMC) that the July rate cut did not mark the start of an easing cycle sapped risk appetite, causing large losses in global equity markets, while core sovereign bond yields continued to move lower on account of falling term premia. Despite the recent risk-off episode, financial market conditions remain loose in both advanced and emerging economies.

Global growth is projected to decelerate this year. A number of headwinds continue to weigh on the global economy. Global manufacturing activity is expected to remain weak, mainly on the back of declining growth in global investment and consumption of durable goods, which form a large part of manufacturing output. As uncertainty related to the future of international trading relations mounts, global investment growth is unlikely to regain traction. Recent analysis shows that deteriorating financing conditions, rising macroeconomic uncertainty and unfavourable demand shocks weighed negatively on global investment growth in the second half of 2018 and the beginning of 2019.^[1] Faced with a slowing global economy, a number of policymakers around the globe have adopted accommodative measures to cushion the negative impact of economic headwinds. In China, fiscal stimulus measures to cushion the slowdown in domestic demand are expected to have an effect mostly in the second half of this year. In the United States, in addition to the sizeable pro-cyclical fiscal stimulus and the recent agreement on new public spending caps, the Federal Reserve System decided to cut its benchmark interest rate with a view to supporting the ongoing economic expansion. A number of other countries have also eased monetary policy (e.g. Australia, Brazil, South Korea, Indonesia, India and Turkey).

Looking ahead, global growth is projected to gradually recover over the medium term but to remain below its long-term average. Developments in global growth are being shaped by three main forces. Across advanced economies, the cyclical momentum is projected to slow as capacity constraints become increasingly binding amid positive output gaps and low unemployment rates across key economies, while, towards the end of the projection horizon, policy support is expected to gradually diminish. In addition, the progressive slowdown of the Chinese economy and its rebalancing from investment to consumption are projected to weigh negatively on global growth and on trade in particular. At the same time, the contribution of EMEs (excluding China) to global growth, while still positive, is expected to be weaker than envisaged in the June 2019 Eurosystem staff macroeconomic projections. This is on account of recent data suggesting that the projected recovery from past recessions is materialising at a slower pace than previously assumed. Moreover, although so far the recent financial market stress in Argentina has not spilled over to other emerging markets, it points to the underlying fragility of the recovery in some EMEs. Overall, the pace of global expansion is expected to settle at rates below those seen prior to the 2007‑08 financial crisis.

Turning to developments in individual countries, in the United States, activity is expected to remain resilient in the near term, despite the headwinds related to the trade dispute with China and the less favourable external environment. The US economy’s performance has so far remained robust, reflecting a strong labour market and consumer spending. The lifting of spending caps for the 2020/21 financial year and a two-year suspension of the federal debt limit agreed by Congress at the end of July will further support economic growth. Financial conditions also remain supportive. Following 3.1% real GDP growth in annual terms in the first quarter of 2019, growth moderated to 2.0% in the second quarter, reflecting the unwinding of temporary factors (e.g. positive contributions from inventories and falling imports), while private consumption and government spending remained supportive of economic activity overall. Annual headline consumer price inflation picked up marginally to 1.8% in July from 1.6% in the previous month, largely on account of core inflation, while energy prices declined. Consumer price inflation excluding food and energy increased slightly, rising to 2.2% in July. Growth is projected to gradually return to the potential growth rate of just below 2%, while consumer price inflation is expected to remain above 2% over the medium term.

The economy in China remains on a gradually slowing trajectory. In the second quarter of 2019 annual GDP growth slowed to 6.2%, from 6.4% in the first quarter, owing to weak final consumption that was only partially compensated for by an improvement in investment. Looking ahead, growth is projected to decelerate further in 2020 and 2021, while no additional fiscal support measures have been announced in response to the latest escalation in the trade dispute. Overall, the deceleration in economic activity reflects the past effects of the deleveraging campaign to contain financial risks, the government’s focus on rebalancing the economy away from investment and the impact of the ongoing trade tensions with the United States. Progress with the implementation of structural reforms is projected to result in an orderly transition to a more moderate growth path that is less dependent on investment and exports.

In Japan, underlying growth momentum remains muted. Growth in the second quarter of 2019 was 0.4% (quarter on quarter), which was better than expected, largely owing to a number of transitory factors, including stronger consumer spending on account of the Golden Week holiday period and higher durable goods purchases. The latter is likely to have partly reflected frontloaded demand ahead of the consumption tax hike scheduled for October 2019. However, exports remained subdued and industrial output and sentiment in the manufacturing sector deteriorated amid weakening external demand and lingering policy uncertainty. Net trade made a negative contribution, with exports remaining flat, while imports rebounded from the weakness observed in the previous quarter. While the near-term profile will be determined by the forthcoming consumption tax hike, implying frontloaded consumption in the third quarter and subsequent payback, economic activity is projected to remain on a moderate trajectory thereafter.

In the United Kingdom, real GDP growth contracted in the second quarter of 2019, largely on account of the uncertainty surrounding Brexit. Real GDP growth has displayed some volatility since the start of the year, largely reflecting changes in activity patterns related to the original 29 March Brexit deadline. After growing by 0.5% (quarter on quarter) in the first quarter, real GDP contracted by 0.2% in the second. This was the first quarter of negative growth since 2012 and reflected lower investment and, following the last-minute extension of the Brexit deadline, a reversal of the strong inventory build-up seen in the first quarter. Despite a marked depreciation in the pound sterling since the start of 2019, exports contracted by 3.3% in the second quarter. The net trade contribution remained nonetheless positive, as imports, particularly of goods from the EU, fell by even more than exports (-12.9% quarter on quarter). Growth in domestic consumption remained robust (0.5% quarter on quarter) in the second quarter, supported in part by stronger real wage growth. Survey-based evidence points to some continued slowing of economic activity in the coming quarter. Annual CPI inflation increased modestly to 2.0% in the second quarter, and further to 2.1% in July, largely on account of the recent stronger adverse exchange rate movements. Ongoing uncertainties related to Brexit modalities have recently been reflected in further volatility in the pound sterling and, on the real economy side, are likely to result in further volatility in quarterly real GDP growth and muted growth over the medium term.

In central and eastern European countries, growth is projected to remain robust over the projection horizon, but more moderate than in 2018. Solid consumer spending backed by strong labour markets is expected to support economic activity going forward. Investment growth is forecast to remain strong, though it will moderate somewhat against the backdrop of a more advanced phase of the EU funds cycle. Furthermore, the slowdown in global trade is weighing on the growth outlook for this region. Over the medium term, the pace of economic expansion in these countries is expected to decelerate further towards potential.

The outlook for economic activity in large commodity-exporting countries points to subdued growth. In Russia, activity in the second quarter was adversely affected by the feed-in of contaminated oil into a key export pipeline, triggering large-scale disruptions along the supply chain. Although temporary, this will weigh on growth in 2019, which has already been affected by an unexpectedly sharp contraction in the first quarter due to weak investment, weak net exports and substantial downward revisions of historical data. Going forward, the outlook for growth in Russia is being shaped by developments in global oil markets, the implementation of fiscal and structural policies, and the international sanctions under which the economy is currently operating. As a result, growth is expected to decelerate somewhat in the medium term. Growth in Brazil is projected to remain subdued, owing to uncertainty surrounding the pension reforms and concerns about fiscal sustainability. Idiosyncratic shocks at the beginning of the year (due to a mining disaster) also weighed negatively on activity. Sluggish domestic demand and persistent uncertainty coupled with substantial spare capacity are holding back a more vigorous investment response and have affected confidence negatively.

In Turkey, economic activity surprised significantly to the upside in the first half of 2019. Following a sharp contraction in the fourth quarter of 2018, the economy recovered in early 2019 on account of a sizeable fiscal stimulus ahead of the local elections in March. The economy continued to grow at a solid pace in the second quarter, despite some unwinding of the fiscal stimulus, owing to strong household consumption and a positive net trade contribution. Investment, on the other hand, continued to contract sharply on account of elevated political uncertainty and tight financing conditions. Looking ahead, growth is expected to weaken for the remainder of 2019 and to gradually accelerate towards the end of the projection horizon.

Global trade weakened significantly in the first half of the year. Global trade growth turned negative in the first quarter and remained weak in the second. The trade weakness is largely explained by slowing industrial activity, heightened trade tensions and, to some extent, a weaker Asian tech cycle.^[2] The contraction in global trade was broad-based across countries. In addition to one-off factors (e.g. temporarily weak domestic demand in the United States in view of the partial federal government shutdown in the first quarter and a contraction in UK imports in the second quarter following the stockpiling efforts of the previous quarter), the weakness in trade also stemmed from weak intra-Asian trade. The latter appears to be related to the slowdown in China’s domestic demand in the context of large regional value chain linkages. According to CPB data, the volume of global merchandise imports, excluding the euro area, contracted by 0.6% in June in three-month-on-three-month terms, confirming continued subdued trade momentum in the second quarter (see Chart 2). As survey indicators on new export orders continue to signal a further deterioration, the current weakness in global trade is likely to continue in the near term.

Since August the trade dispute between the United States and China has intensified significantly. In early August, following a bilateral meeting with the Chinese authorities, the United States announced the imposition of 10% tariffs on around USD 300 billion worth of US imports from China. These tariffs are being implemented in two stages, on 1 September and 15 December. Initially, the Chinese authorities announced only in-kind retaliatory measures consisting of the decision to suspend imports of US crops. However, towards the end of August, further retaliatory measures were announced with the decision to impose additional tariffs of 5% or 10% on USD 75 billion worth of Chinese imports from the United States and to reinstate previously suspended tariffs on cars and car parts. This latest move prompted a further escalation as the United States announced the imposition of additional 5% tariffs on all US imports from China (worth around USD 550 billion).^[3] This further intensification of the trade dispute between the two countries will weigh negatively on global activity and trade. Meanwhile, other trade issues also remain unresolved. The US administration has delayed taking a decision on possible increases in car tariffs until mid-November 2019, while talks with the EU on a new trade agreement, announced in July 2018, are still ongoing.

Global economic growth is projected to weaken this year, and to recover only gradually over the medium term. According to the September 2019 ECB staff macroeconomic projections, global real GDP growth (excluding the euro area) is projected to decelerate to 3.1% this year, from 3.8% in 2018. This reflects increasing headwinds to global growth in an environment of high and rising political and policy uncertainty. Over the period 2020‑21 growth in world economic activity is projected to stabilise at 3.5%, as the (cyclical) slowdown in key advanced economies and China’s transition to a more moderate growth path are expected to be only partly counterbalanced by a gradual recovery in several key EMEs. As the growth headwinds weigh more significantly on trade-intensive demand components, such as investment, growth in euro area foreign demand is projected to slow more significantly than global activity this year, falling to 1.0%, from 3.7% in 2018. Global imports are projected to increase gradually over the medium term. Compared with the June 2019 Eurosystem staff macroeconomic projections, both global GDP growth and growth in euro area foreign demand have been revised downwards over the forecast horizon. From a geographical perspective, the revisions of euro area foreign demand reflect weaker than expected trade prospects for EMEs, including China to a lesser extent, as well as the outlook of slower import growth across some key trading partners, including the United Kingdom and other European countries outside the euro area.

Downside risks to global activity have intensified lately. A further escalation of trade disputes would pose a risk to global trade and growth. Moreover, a “no deal” Brexit scenario could have more adverse spillover effects, especially in Europe. A sharper slowdown in China’s economy could be harder to counteract with efficient policy stimuli and might prove a challenge to the ongoing rebalancing process in China. Repricing in financial markets might weigh significantly on vulnerable EMEs. A further escalation of geopolitical tensions could also adversely affect global activity and trade.

Global price developments

Developments in oil prices since late July have mainly been shaped by concerns about the global outlook. Following the re-escalation of US‑China trade tensions in early August, oil prices first declined by around 5%, before making up some ground in the second half of the month. Since April, the outlook for global oil consumption has been revised down repeatedly. Accordingly, production cuts by the OPEC+ group of oil producers, which supported oil prices in the first quarter of the year in particular, have not been sufficient to offset headwinds from concerns about demand for oil. The impact on prices of recent geopolitical uncertainties in the Middle East has also been limited so far. Going forward, risks to oil prices appear broadly balanced. While further weakness in global activity would weigh on prices, restrictions to supply would bolster them. Indeed, Saudi Arabia and Russia have already indicated the possibility of further OPEC+ production cuts in the near future, which could put some renewed upward pressure on prices.

In the September 2019 ECB staff macroeconomic projections, oil prices are foreseen to decline over the projection horizon. Amid short-term volatility, concerns about demand for oil and the re-intensification of trade tensions have been a drag on oil prices, despite the agreement between OPEC and other major oil producers to curb production. Consequently, the oil price assumptions underpinning the September 2019 ECB staff macroeconomic projections were around 8.3% lower for 2019 (and 13.4% and 10.3% lower for 2020 and 2021 respectively) relative to the assumptions underpinning the June 2019 Eurosystem staff macroeconomic projections. Since the cut-off date for the September projections, however, the price of oil has increased marginally, with Brent crude standing at USD 61 per barrel on 5 September.

Global inflationary pressures remain moderate. In countries belonging to the Organisation for Economic Co-operation and Development (OECD), annual headline consumer price inflation averaged 2.1% in July 2019, up from 2.0% in the previous month. The increase is due to a positive contribution from core inflation (excluding food and energy) (see Chart 3), which picked up to 2.3% from 2.2% in the previous month, while energy inflation remained flat. Tight labour market conditions across the major advanced economies have so far translated into only moderate wage increases, suggesting that the underlying inflation pressures remain subdued. Nevertheless, they should recover gradually over the projection horizon, reflecting diminishing slack.

Looking ahead, global inflationary pressures are expected to remain contained. Growth in the export prices of the euro area’s competitors is expected to weaken sharply this year and gradually decelerate over the medium term. This reflects the impact of a downward sloping oil price futures curve, which is expected to outweigh the upward pressure arising from gradually diminishing global spare capacity.

Financial developments

Since the Governing Council’s meeting in June 2019, global long-term risk-free rates have declined amid market expectations of further accommodative monetary policy in an environment of heightened global trade uncertainty. This decline in risk-free rates has supported the prices of euro area equities and corporate bonds. Meanwhile, corporate earnings expectations have fallen somewhat in response to persistent doubts about the global macroeconomic outlook. In foreign exchange markets, the euro remained broadly unchanged in trade-weighted terms.

Long-term yields in both the euro area and the United States declined materially. During the period under review (6 June to 11 September 2019), the GDP-weighted euro area ten-year sovereign bond yield fell by 55 basis points to ‑0.06% (see Chart 4). Ten-year sovereign bond yields in the United States and the United Kingdom also dropped significantly, by 38 and 19 basis points respectively. The sizeable falls in government bond yields partly reflect a reappraisal of interest rate expectations in major jurisdictions in the context of heightened uncertainty with regard to global trade relations and the broader macroeconomic outlook.

Sovereign bond spreads relative to the risk-free OIS rate were broadly unchanged in most euro area countries. Sovereign bond spreads were largely stable throughout the review period, with the exception of the Italian market where the ten-year spread declined by 1.1 percentage points following the anticipation and subsequent formation of a new government. Overall, the spread between the GDP-weighted average of euro area ten-year sovereign bond yields and the ten-year OIS rate declined slightly, standing at 0.26 percentage points on 11 September.

The euro overnight index average (EONIA) stood, on average, at ‑36 basis points over the review period. Excess liquidity decreased by approximately €141 billion to around €1,763 billion. The decline in excess liquidity was mainly driven by an increase in liquidity-absorbing autonomous factors and, to a lesser extent, by voluntary repayments in the second series of targeted longer-term refinancing operations (TLTRO‑II). For further details on developments in liquidity conditions, see Box 2.

The EONIA forward curve shifted downwards and inverted markedly at shorter horizons. At the end of the review period, the curve displayed a trough of close to 40 basis points below the prevailing level of EONIA around the fourth quarter of 2021 and remained below zero for all horizons up to 2027, reflecting market expectations of a prolonged period of negative interest rates (see Chart 6).

Non-financial equity prices increased in both the euro area and the United States, supported by a decline in risk-free rates. The equity prices of euro area non-financial corporations (NFCs) increased by 6% overall, whereas euro area bank shares increased by close to 2% (see Chart 7). The underperformance of bank equity prices might be related to a generally subdued profitability outlook linked to, among other things, high cost structures, ongoing business model adjustment and the challenges of sufficiently benefiting from digitalisation-related efficiencies. In the United States, NFC and bank share prices rose by around 5% and 4%, respectively. Global equity prices were supported by a considerable decline in risk-free rates. However, this support was somewhat offset by an increase in risk premia in response to an intensification of global trade uncertainty and by some downward revisions of corporate earnings expectations, probably in response to lingering doubts about the global macroeconomic outlook.

Euro area corporate bond spreads declined somewhat. Overall, the spread between the yield on investment-grade euro area NFC bonds and the risk-free rate declined by 5 basis points to stand at 74 basis points (see Chart 8). Yields on financial sector debt also declined, with their spread to the risk-free rate falling by approximately 10 basis points. While both spreads remain broadly around the average levels that have prevailed since the introduction of the corporate sector purchase programme (CSPP) in March 2016, the most recent declines may have been supported by the expectation of additional monetary policy measures.

In foreign exchange markets, the euro remained broadly unchanged in trade-weighted terms over the review period (see Chart 9). The nominal effective exchange rate of the euro, as measured against the currencies of 38 of the euro area’s most important trading partners, depreciated by 0.6%. The euro weakened against the US dollar (by 2.3%), the Japanese yen (by 2.7%) and the Swiss franc (by 2.1%). The value of the euro also fell vis-à-vis the currencies of most emerging economies. The euro appreciated by 0.6% against the Chinese renminbi, reversing its weaker showing in July. The euro also strengthened against the Brazilian real and the Indonesian rupiah as well as against the pound sterling (by 0.6%) and the currencies of most non-euro area EU Member States.

Economic activity

Euro area economic growth softened in the second quarter of 2019, resuming the moderate performance observed in 2018. In quarter-on-quarter terms, euro area real GDP growth slowed to 0.2% in the second quarter of 2019, supported primarily by an increase in domestic demand, while net exports weighed on growth. Looking ahead, the latest economic indicators and survey results suggest subdued growth. The September 2019 ECB staff macroeconomic projections for the euro area foresee annual real GDP growth at 1.1% in 2019 and 1.2% in 2020, before gradually reaching 1.4% in 2021. Compared with the June 2019 Eurosystem staff macroeconomic projections, the outlook for euro area real GDP growth has been revised down for 2019 and 2020 on account of the deterioration in the short-term outlook, characterised by weaker confidence indicators and continued global uncertainties.

Euro area growth remained moderate in the first two quarters of 2019, with differences across countries becoming more noticeable in the second quarter of the year. Real GDP increased by 0.3%, quarter on quarter, on average in the first two quarters of 2019, continuing at the same average rate of growth as in the previous year (see Chart 10). The moderate performance stems largely from a weakening in foreign demand. Domestic demand continued to be the main driver of economic activity and has been the main GDP component supporting growth since real GDP growth started to slow in early 2018. Changes in inventories made a negligible contribution to real GDP growth in the second quarter of 2019, whereas net trade made a negative contribution, reflecting subdued foreign demand against a background of global policy uncertainty. On the production side, softened economic activity in the second quarter of 2019 was explained by negative growth in the manufacturing sector due to both international trade disputes and country-specific developments (see Box 3). The services sector lost some momentum in the second quarter of 2019 in terms of value added, possibly reflecting some spillover stemming from manufacturing sector weakness.

Euro area labour markets are still improving, albeit at a moderate pace. Employment increased by 0.2%, quarter on quarter, in the second quarter of 2019, after 0.4% in the first quarter, in line with output growth. Compared with the first quarter, employment growth remained unchanged at 0.4% in the services sector while it weakened in the non-construction industry sector to 0.1%, after recording an increase of 0.4% in the first quarter of 2019. In contrast, employment in the construction sector declined by 0.2%, after increasing by 0.2% in the previous quarter.

Looking ahead, recent data and survey-based indicators continue to point to positive employment growth, with some further moderation. The euro area unemployment rate in July stood unchanged from the previous month at 7.5%, the lowest rate since July 2008. Although short-term survey-based indicators have fallen from the high levels recorded in 2018, they continue to suggest positive employment growth in the near future, with some moderation.

Developments in private consumption continue to be driven by the recovery in the labour market. Private consumption rose by 0.2%, quarter on quarter, in the second quarter of 2019, following somewhat stronger growth in the first quarter. The latest developments in retail trade and passenger car registrations are broadly in line with steady consumption growth expected in the near term. From a longer-term perspective, increasing labour income is supporting consumer spending, which is also reflected in still robust consumer confidence (see Box 5). In addition, the strengthening of household balance sheets remains an important factor underpinning resilient consumption growth, with household creditworthiness being a key determinant of consumers’ access to credit.

Business investment growth is expected to continue to be supported by accommodative financing conditions, although subdued earnings expectations suggest some moderation. Euro area investment growth (excluding construction) rebounded in the second quarter of 2019, rising to 1.0% in quarter-on-quarter terms from ‑0.9% in the first quarter of 2019. Business investment is expected to see moderate growth in the near term, however, in line with relatively weak business margins and firm valuations. Earnings expectations for listed companies in the euro area suggest a certain degree of moderation regarding investment decisions, although favourable financing conditions should be reflected in non-financial corporations’ access to credit and thus boost business investment growth.

Developments in housing markets are expected to support growth, albeit with a moderating momentum. Quarterly growth in housing investment slowed significantly to 0.3% in the second quarter of 2019 from 1.4% in the previous quarter, posting the lowest outcome since the first quarter of 2017. Recent short-term indicators and survey results suggest some decelerating momentum in the third quarter of 2019, although they remain above historical averages. The European Commission construction confidence indicator for July and August points to a positive, albeit decelerating, momentum in the third quarter. Similarly, the Purchasing Managers’ Index (PMI) indicator for construction output and its residential component indicated broadly flat growth expectations in the construction sector in July and August, standing below the average level recorded in the previous quarter.

Growth in euro area exports weakened further in the second quarter of 2019 to 0.0%, owing to a 0.1% decline in goods export volumes. Exports of services continued to weaken but still expanded by 0.4%. The overall performance mainly reflected extra-euro area exports, and specifically the abrupt fall in exports to the United Kingdom related to persistent uncertainty regarding Brexit. Conversely, some support was provided by overall exports to Asia (excluding China) and primarily chemical exports to the United States. Looking ahead, leading indicators suggest anaemic growth for euro area exports, although the indicator for new manufacturing export orders outside the euro area provided somewhat more positive signals, as did some shipping indices over the summer.

The latest economic indicators and survey results confirm ongoing downside risks to the euro area economic growth outlook. Euro area industrial production (excluding construction) saw a broad-based month-on-month decline of 1.6% in July, most notably driven by a decrease in capital goods production. As regards survey information, the European Commission’s Economic Sentiment Indicator (ESI) increased between July and August to stand above its long-term average. Compared with the previous quarter, however, it has declined on average so far in the third quarter of 2019. The composite output PMI remained muted throughout the second quarter of 2019. Despite the slight improvement seen more recently, in August it remained below its long-term average, suggesting a mild outlook for economic growth.

The ECB’s monetary policy will continue to underpin domestic demand against the deterioration in the short-term outlook for euro area real GDP growth. Private consumption is supported by healthy household balance sheets, robust labour markets and ongoing employment gains. Business investment is fostered by favourable financing conditions and solid demand, despite weaker corporate profitability. Housing investment remains robust overall. The slowdown in global activity is, however, expected to continue to weigh on euro area growth and have an impact on euro area exports against a background of ongoing global policy uncertainty and heightened geopolitical risks.

The September 2019 ECB staff macroeconomic projections for the euro area foresee annual real GDP increasing by 1.1% in 2019, 1.2% in 2020 and 1.4% in 2021 (see Chart 12). Compared with the June 2019 Eurosystem staff macroeconomic projections, the outlook for euro area real GDP growth has been revised down for 2019 and 2020 on account of the deterioration in the short-term outlook. The risks surrounding the euro area growth outlook remain tilted to the downside. Global policy uncertainty, rising protectionism and geopolitical factors have regained prominence recently and continue to be a drag on euro area growth.

Prices and costs

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.0% in August 2019, unchanged from July. Measures of underlying inflation remained generally muted, and indicators of inflation expectations stand at low levels. While labour cost pressures strengthened and broadened amid high levels of capacity utilisation and tightening labour markets, their pass-through to inflation is taking longer than previously anticipated. Looking ahead, underlying inflation is expected to increase over the medium term, supported by the ECB’s monetary policy measures, the ongoing economic expansion and robust wage growth. This assessment is also broadly reflected in the September 2019 ECB staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.2% in 2019, 1.0% in 2020 and 1.5% in 2021. Compared with the June 2019 Eurosystem staff macroeconomic projections, the outlook for HICP inflation has been revised down over the whole projection horizon, reflecting lower energy prices and the weaker growth environment. Annual HICP inflation excluding energy and food is expected to be 1.1% in 2019, 1.2% in 2020 and 1.5% in 2021.

Headline inflation was unchanged in August. According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.0% in August, unchanged from July and down from 1.3% in June (see Chart 13). Energy inflation continued to decline and turned negative in August, but was offset by higher food inflation than in July.

Measures of underlying inflation remained generally muted. HICP inflation excluding energy and food fell from 1.1% in June to 0.9% in July and August – the development was related partly to calendar effects and methodological changes.^[4] Measures of underlying inflation that tend to be less volatile than HICP inflation excluding energy and food have also been fairly stable over recent quarters (data available up to July only; see Chart 14). HICP inflation excluding energy, food, travel-related items and clothing was unchanged at 1.1% in June and July. The Persistent and Common Component of Inflation (PCCI) increased slightly from 1.2% in June to 1.3% in July. The Supercore measure decreased from 1.4% in June to 1.3% in July.^[5] Overall, measures of underlying inflation continued to move sideways but are up from their lows in 2016.

The latest indicators of price pressures for non-energy industrial goods consumer prices provided mixed signals. Producer price inflation for domestic sales of non-food consumer goods decreased to 0.8% in July from 0.9% in May and June, but remained well above its long-term average. The corresponding rate of import price inflation increased to 0.8% in July, from 0.5% in June. Earlier in the pricing chain, however, domestic producer price inflation for intermediate goods continued to decline, likely reflecting in part the recent decrease in energy prices. Price pressures also declined at the very early stages of the pricing chain, with both oil and non-oil commodity prices recording a decrease in the year-on-year inflation rate in August compared with July.

Wage growth has remained robust. Annual growth in compensation per employee was 2.1% in the second quarter of 2019, down slightly from the 2.2% recorded in the first quarter (see Chart 15). The figures for the first and second quarters of 2019 were affected by a significant drop in social security contributions.^[6] Annual growth in wages and salaries per employee, which excludes social security contributions, was 2.4% in the second quarter, after 2.6% in the first quarter and 2.3% on average for the previous year. Annual growth in negotiated wages in the euro area was 2.0% in the second quarter of 2019, down from 2.3% in the first quarter, with the reduction driven mainly by one-off payments in Germany. Looking through temporary factors, annual growth in compensation per employee has stabilised since mid‑2018 at a level slightly above its historical average of 2.1%.^[7]

Market-based measures of longer-term inflation expectations have remained at very low levels, while survey-based expectations also stand at historical lows. Market-based measures of inflation expectations fell somewhat over the review period, to hover just above their historical lows. The five-year forward inflation-linked swap rate five years ahead stood at 1.22% on 11 September 2019, around 7 basis points below its level at the time of the July monetary policy meeting of the Governing Council. While the probability of deflation based on market expectations nonetheless remains low, the forward profile of market-based measures of inflation expectations continues to point to a prolonged period of low inflation, with only a very gradual return to inflation levels below, but close to, 2%. Survey-based long-term inflation expectations stand at record lows, according to the ECB Survey of Professional Forecasters for the third quarter of 2019, as well as the July releases from Consensus Economics and the Euro Zone Barometer.

The September 2019 ECB staff macroeconomic projections expect underlying inflation to increase over the medium term. These projections, which are based on the information available at the end of August, expect headline HICP inflation to average 1.2% in 2019, 1.0% in 2020 and 1.5% in 2021, compared with 1.3%, 1.4% and 1.6% respectively in the June 2019 Eurosystem staff macroeconomic projections (see Chart 17). The revisions are largely explained by the energy component, which was revised notably downwards for both 2019 and 2020, due to lower oil prices. HICP inflation excluding energy and food is projected to move sideways in 2020 and strengthen in 2021, supported by the expected pick-up in activity and the associated recovery in profit margins as past increases in labour costs feed into prices. HICP inflation excluding energy and food is expected to rise from 1.1% in 2019 to 1.2% in 2020 and 1.5% in 2021. This profile represents a downward revision, mainly reflecting weaker than expected data outturns so far this year.

Money and credit

In July 2019 the annual growth of broad money increased markedly, while loans to the private sector remained broadly unchanged. M3 growth remained resilient in the face of the fading-out of the mechanical contribution of net purchases under the asset purchase programme (APP) and weakening economic momentum. At the same time, favourable bank funding and lending conditions continued to support loan flows and thereby economic growth. Net issuance of debt securities by non-financial corporations (NFCs) was robust in the second quarter of 2019, after recording the highest historical level of net issuance in the first quarter of 2019, amid a continuous improvement in bond market conditions.

Broad money growth increased markedly in July. The annual growth rate of M3 rose to 5.2% in July 2019 from 4.5% in June 2019 (see Chart 18), returning to the solid growth rates observed in the period from 2015 to 2017. Higher broad money growth was supported by lower opportunity costs and remained resilient in the face of the fading-out of the positive mechanical contribution of net purchases under the APP and weakening economic momentum. The narrow monetary aggregate M1, which includes the most liquid components of M3, continued to be the main contributor to broad money growth. The annual growth rate of M1 increased in July to 7.8%, from 7.2% in June, continuing its recovery observed since the start of the year.

Overnight deposits, the main contributor to money growth, continued to expand at a robust pace. The annual growth rate of overnight deposits increased further to 8.3% in July, reflecting a strong rise in the annual growth rate of overnight deposits held by both NFCs and households. Among the M1 components, the annual growth of currency in circulation remained solid, although not exceptionally high by historical standards. This indicates no pervasive substitution into cash in an environment of very low or negative interest rates for the euro area as a whole. Short-term deposits other than overnight deposits (i.e. M2 minus M1) remained supported by the lower opportunity costs of holding M3, making a neutral contribution to M3 growth in July. At the same time, marketable instruments (i.e. M3 minus M2) continued to contribute negatively to broad money growth as a result of the relatively low remuneration of these instruments.

External monetary inflows strengthened their contribution to M3 growth further in July. The decreasing mechanical impact of the APP on M3 growth has been largely offset by positive contributions from credit to the private sector, which remained the main source of money creation (see the blue parts of the bars in Chart 19). The positive contribution to M3 growth from general government securities held by the Eurosystem, which reflects the mechanical contribution of the APP to M3 growth, has become marginal (see the red parts of the bars in Chart 19). In recent months, the smaller contribution made by the APP has been replaced by external monetary flows (see the yellow parts of the bars in Chart 19). The increasing contribution from net external assets reflects greater interest on the part of foreign investors in euro area assets.

The annual growth rate of loans to the private sector remained broadly unchanged with weakness in some cyclically sensitive segments. The annual growth rate of MFI loans to the private sector (adjusted for loan sales, securitisation and notional cash pooling) stood at 3.6% in July, compared with 3.5% in June (see Chart 18). This development was mainly owing to the slight increase in the annual growth rate of loans to households to 3.4% in July, compared with 3.3% in June. Annual loan growth to households thus continued on its gradual upward trend, benefiting from further improvements in the labour market and still favourable housing market developments. The annual growth rate of loans to NFCs remained stable at 3.9% in July, after reaching its turning point in September 2018 (at 4.3%). This was in line with its lagging cyclical pattern with respect to real economic activity and the 2018 slowdown in aggregate demand. In particular, this is reflected in the weakness of cyclically sensitive segments, such as short-term loans and loans to the manufacturing sector. Overall, loan growth continued to benefit from favourable lending conditions. Moreover, the growth in loans to firms and households is characterised by considerable heterogeneity across countries (see Charts 20 and 21), reflecting, inter alia, cross-country differences in the business cycle, variations in the availability of other funding sources and heterogeneity in house price developments across countries.

Banks’ debt funding conditions have improved further. Since the beginning of 2019 the composite cost of debt financing for euro area banks has decreased further, broadly in line with developments in market reference rates (see Chart 22). This development has been driven mainly by a considerable decline in bank bond yields, while euro area banks’ deposit rates have remained close to their historical lows. Compared with deposits, bank bonds have remained the more expensive source of funding, accounting for a limited share in banks’ overall debt funding. The improvement in banks’ debt funding costs was widespread across the largest euro area countries. Moreover, in their responses to the ECB’s bank lending survey, euro area banks reported improved access to funding in the first half of 2019, primarily on account of their access to debt securities funding. At the same time, the level of bank funding costs remained heterogeneous across the largest euro area countries. In the first half of 2019 euro area banks’ loan-deposit margins for new business decreased somewhat. In this respect, the ability to charge negative rates on deposits, which is heterogeneous across countries for NFC deposits, significantly affects the size of these margins. In this way, the compression of loan-deposit margins exerts a dampening impact on bank profitability. However, this is compensated for by the positive impact of the low or even negative interest rate environment on credit quality (which reduces provisioning costs) and lending volumes. Overall, euro area banks’ funding conditions continue to be favourable, reflecting the ECB’s accommodative monetary policy stance and the strengthening of banks’ balance sheets. Despite the progress made by banks in consolidating their balance sheets, for instance by reducing non-performing loans, the level of euro area bank profitability remains low.

Bank lending rates for NFCs and households decreased further. This was broadly in line with developments in market reference rates. In July 2019 the composite bank lending rate for NFCs (see Chart 23) stood at 1.56%, only marginally above its historical low, while the composite bank lending rate for housing loans reached a new historical low in July, when it declined to 1.61% (see Chart 24). Competitive pressures and more favourable bank funding costs dampened lending rates for loans to euro area NFCs and households. Overall, composite bank lending rates for loans to NFCs and households have fallen significantly since the ECB’s credit easing measures were announced in June 2014. Between May 2014 and July 2019 composite lending rates on loans to NFCs and households fell by around 140 and 130 basis points respectively. The reduction in bank lending rates for loans to NFCs, as well as for loans to small firms (assuming that very small loans of up to €0.25 million are granted primarily to small firms), was particularly significant in those euro area countries more affected by the financial crisis. This indicates a more uniform transmission of monetary policy to bank lending rates across euro area countries and firm sizes.

The annual flow of total external financing to euro area NFCs was broadly unchanged in the second quarter of 2019, after contracting strongly in the previous quarter. Borrowing from banks strengthened over the quarter, while net issuance of debt securities stood at solid levels. By contrast, net issuance of listed shares and loans from non-monetary financial institutions remained weak. Compared with earlier economic slowdowns, debt financing flows to NFCs have remained quite resilient. This reflects favourable debt financing conditions, a greater contribution from services and real estate-related activities to overall economic growth, solid business investment growth and a slowdown in profit growth, all of which have supported debt financing volumes.

In the second quarter of 2019 the net issuance of debt securities by NFCs remained quite robust, albeit decreasing, compared with the level recorded in the previous quarter, which was the highest level recorded since 1999. The moderation in the net issuance of debt securities in the second quarter of 2019 is in line with the typical seasonal pattern of the series and the pay-back effect following their exceptional strength – at €42 billion – in the previous quarter. Furthermore, from April to June 2019 the cost of market-based debt financing declined by a further 25 basis points and continued to provide support to net debt securities issuance. Taking a medium-term perspective, the gradual slowdown in annual net issuance flows that started in 2017 seems to have stopped at least temporarily (see Chart 25), thus confirming signs of a gradual stabilisation observed since the beginning of 2019. Market data suggest that the net issuance of debt securities in July and August 2019 has remained strong, although confined to investment-grade issuers, while high-yield issuance remains much more muted than it was in the second quarter of 2019. The net issuance of listed shares continued to weaken and turned negative in the second quarter of 2019, reflecting both sluggish M&A activity and a continuous increase in the cost of equity financing.

In June 2019 the cost of financing for NFCs remained slightly above the historical minimum reached in April 2019. In June 2019 the overall nominal cost of external financing for NFCs, comprising bank lending, debt issuance in the market and equity finance, stood at 4.6%. This was 16 basis points higher than in April 2019, when the cost of financing series reached its historical low, but still lower than the level seen in mid‑2014, when market expectations regarding the introduction of the public sector purchase programme began to emerge. The increase in the cost of financing is attributable to the higher cost of equity driven by increasing risk premia, which was only partially offset by a further decline in the cost of market-based debt. In the following two months, the overall cost of financing is estimated to have remained broadly unchanged at its June 2019 value.

Fiscal developments

The euro area fiscal deficit is projected to increase on account of lower primary balances over the entire forecast horizon (2019‑21). A favourable interest rate-growth differential and positive, albeit declining, primary balances continue to maintain the euro area government debt-to-GDP ratio on a downward path. The aggregate fiscal stance for the euro area is expected to be mildly expansionary, providing some support to economic activity. In view of the weakening economic outlook and the continued prominence of downside risks, governments with fiscal space that are facing a slowdown should act in an effective and timely manner. At the same time, in countries where public debt is high, governments need to pursue prudent policies and deliver on structural balance targets. This will create the conditions for automatic stabilisers to operate freely.

The euro area general government budget balance is projected to decrease over the projection horizon. ^[8] Based on the September 2019 ECB staff macroeconomic projections, the general government deficit ratio for the euro area is expected to increase from 0.5% of GDP in 2018 to 0.8% of GDP in 2019. This development is driven by a lower cyclically adjusted primary balance, which is partly offset by lower interest expenditure, while the cyclical component remains broadly unchanged. The higher deficit is expected to persist in 2020 and to increase further to 1.0% of GDP in 2021 (see Chart 26) owing to a continued decline in the cyclically adjusted primary balance.

The outlook for the euro area general government budget balance is broadly unchanged compared to the June 2019 Eurosystem staff projections. While the deficit ratio is projected to be slightly lower in 2019 on account of a higher cyclically adjusted primary balance, it has been revised slightly upwards for 2021, reflecting a less favourable cyclical component.

The aggregate fiscal stance for the euro area is assessed to be mildly expansionary over the entire projection horizon. ^[9] The loosening of the stance in 2019 mainly results from cuts to direct taxes in France and Germany, and increases in public expenditure in Germany. In the following two years, the stance will continue to be mildly expansionary, mainly on account of further cuts to direct taxes and social security contributions in most of the larger euro area countries.

The euro area aggregate public debt-to-GDP ratio is projected to continue to decline. According to the September 2019 ECB staff macroeconomic projections, the aggregate general government debt-to-GDP ratio in the euro area is expected to decline from 85.4% of GDP in 2018^[10] to 81.2% of GDP in 2021. The projected reduction in the government debt ratio is supported by a negative interest rate-growth differential^[11] and continued primary surpluses, although these are expected to decline over time (see Chart 27). Over the projection horizon the debt ratio is expected to fall in most euro area countries, although it will continue to far exceed the reference value of 60% of GDP in some of them. Compared with the June 2019 projections, the decline in the aggregate euro area debt-to-GDP ratio is expected to be slower, with the projected ratio for 2021 revised upwards by 0.7 percentage points. This increase reflects an upward revision of the interest rate-growth differential, lower primary surpluses and a statistical revision of the debt-to-GDP ratio for 2018.

Countries need to prepare 2020 budgets in line with the provisions of the EU fiscal framework. In view of the weakening economic outlook and the continued prominence of downside risks, governments with fiscal space that are facing a slowdown should act in an effective and timely manner. In countries where public debt is high, governments need to pursue prudent policies and deliver on structural balance targets. This will create the conditions for automatic stabilisers to operate freely. All countries should reinforce their efforts to achieve a more growth-friendly composition of public finances.

Boxes

The September policy package

Prepared by Julian Schumacher and Ine Van Robays

At its September meeting, the Governing Council faced a more protracted slowdown of the euro area economy than previously anticipated, persistent and salient downside risks and a further delay in the convergence of inflation towards its medium-term inflation aim. The outlook for inflation has continued to fall short of the Governing Council’s aim on the back of slower euro area growth dynamics. Inflation rates, both realised and projected, have failed to pick up in recent months, measures of underlying inflation have remained generally muted, and market and survey-based indicators of long-run inflation expectations stand at historically low levels. This picture is also reflected in the latest ECB staff macroeconomic projections for the euro area, which show a further downgrade of the inflation and growth outlook.

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Liquidity conditions and monetary policy operations in the period from 17 April to 30 July 2019

Prepared by Annette Kamps and Christian Lizarazo

This box describes the Eurosystem liquidity conditions and the ECB’s monetary policy operations during the third and fourth reserve maintenance periods of 2019, which ran from 17 April to 11 June 2019 and from 12 June to 30 July 2019, respectively. Throughout this period the interest rates on the main refinancing operations (MROs), the marginal lending facility and the deposit facility remained unchanged at 0.00%, 0.25% and ‑0.40% respectively. In parallel, the Eurosystem continued the reinvestment phase of its asset purchase programme (APP), reinvesting principal payments from maturing public sector securities, covered bonds, asset-backed securities and corporate sector securities.

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Domestic versus foreign factors behind the fall in euro area industrial production

Prepared by Roberto A. De Santis and Srečko Zimic

After a sharp decline in 2018 amid weak global trade, year-on-year growth in euro area industrial production (excluding construction) recovered marginally in 2019 but remained in negative territory. In the period from January 2018 to June 2019 the year-on-year growth rate of euro area industrial production (excluding construction) fell by 6.3 percentage points overall, from 3.9% to ‑2.4% (see Chart A). This is by far the largest fall recorded among major economies in that period. In the United States, the decline in industrial production started later, in September 2018. Among the largest euro area countries, the biggest declines were recorded by Germany (10.9 percentage points), the Netherlands (5.7 percentage points) and Italy (5.5 percentage points). In France and Spain, industrial production dropped in 2018 in line with developments in all other euro area countries, but reversed its negative trend in 2019; the patterns remain highly volatile, however. The slowdown in manufacturing activity in the euro area seems to have had an adverse impact on growth rates in some sub-components of services, although the services sector overall has so far remained relatively resilient. This box examines the factors behind the developments in euro area industrial production, aiming to quantify the relative importance of foreign versus domestic shocks through the lens of a multi-country structural vector autoregression (SVAR) model.

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How does the current employment expansion in the euro area compare with historical patterns?

Prepared by Vasco Botelho and António Dias da Silva

This box looks at the current employment expansion in the euro area and compares it with past periods of employment growth. Employment in the euro area has grown for almost six consecutive years, from its trough in the second quarter of 2013. Since the start of the current employment expansion, employment has increased by more than 11 million people and the unemployment rate has declined by more than 4 percentage points, with the latter approaching the levels reached before the crisis. Meanwhile, labour productivity growth and real wage growth have been relatively weak. Against this background, this box aims to identify similarities and differences between the current employment expansion and previous episodes of expansion. In particular, it takes a long-term perspective to analyse the relationship between employment growth and GDP growth, the behaviour of unemployment, and the relationship between productivity growth and real wage growth. The analysis relies on annual data from the European Commission AMECO database for the first 12 countries to join the euro area^[12], for the period between 1960 and 2018. These data are then partitioned into ten separate periods of consecutive positive or negative employment growth.^[13] These periods, which identify employment expansions and contractions, are a useful benchmark to assess the strength and maturity of the current employment expansion.

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Household income risk over the business cycle

Prepared by Maarten Dossche and Jacob Hartwig

Household income and wealth inequality have become more important in explaining the macroeconomy. Since the financial crisis, there has been increased awareness that heterogeneity across households and firms is key to understanding business cycle fluctuations (e.g. via balance sheets, credit constraints).^[14] At the same time, public interest in the distributional aspects of economic policies has continued to grow. In addition, the increased availability of microdata makes it possible to document relevant microeconomic stylised facts. In this vein, this box sheds light on the relationship between business cycle fluctuations and income changes at the level of individual workers in the euro area.

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How do profits shape domestic price pressures in the euro area?

Prepared by Elke Hahn

Profits can account for a significant part of domestic price formation and affect the pass-through of changes in costs to final prices. National accounts contain a broad measure of profits, gross operating surplus, which can tell us more about the role of profits for domestic price pressures, as measured in the GDP deflator. Chart A depicts this role in terms of movements in unit profits, thus gross operating surplus divided by real GDP, the measure of profit margins used in this box. Unit profits accounted for roughly one-third of the increase in the euro area GDP deflator over the past two decades. This box illustrates how profits have recently shaped domestic price pressures in the euro area. It explains which factors are the main drivers of the movements in profit margins and discusses how they have likely contributed to their recent developments.

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Articles

Derivatives transactions data and their use in central bank analysis

Prepared by Lena Boneva, Benjamin Böninghausen, Linda Fache Rousová and Elisa Letizia

Data on derivatives transactions have recently become available at a number of central banks, including the ECB, and have opened up new avenues for analysis. Collected as a result of reforms of the over-the-counter (OTC) derivatives market, which were primarily designed to counter systemic risk, the data have numerous applications beyond the domain of financial stability.

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The taxonomy of ECB instruments available for banking supervision

Prepared by Rinke Bax and Andreas Witte

In November 1999, the ECB Monthly Bulletin featured an article on the legal instruments of the European Central Bank. Since being entrusted with the task of supervising credit institutions in 2014, the ECB has adopted a wide range of further legal and non-legal instruments in the context of prudential supervision. These tasks have been conferred on the ECB by the SSM Regulation^[15] and give the ECB the exclusive competence to carry them out with respect to all credit institutions. The SSM Regulation establishes specific types of legal act which the ECB can adopt for the purpose of exercising its tasks under that regulation. The SSM Regulation also stipulates that the ECB’s supervisory tasks must be exercised separately from those relating to monetary policy. This article describes the instruments the ECB has adopted in its role as banking supervisor in recent years.

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Statistics

Statistical annex