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 series of monetary policy decisions at its monetary policy meeting on 6 June to support the convergence of inflation towards levels of below, but c lose to, 2%. Despite the somewhat better than expected data for the first quarter, the most recent information indicates that global headwinds continue to weigh on the euro area outlook. The prolonged presence of uncertainties, related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, is leaving its mark on economic sentiment. At the same time, further employment gains and increasing wages continue to underpin the resilience of the euro area economy and gradually rising inflation. Against this overall background, the Governing Council decided to keep the key ECB interest rates unchanged and adjust its forward guidance on the key ECB rates to indicate its expectation that they will remain at their present levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. It also reiterated its forward guidance on reinvestments. And, finally, it decided upon the modalities of the new series of quarterly targeted longer-term refinancing operations (TLTRO III), most notably their pricing parameters. The Governing Council also assessed that, at this point in time, the positive contribution of negative interest rates to the accommodative monetary policy stance and to the sustained convergence of inflation is not undermined by possible side effects on bank-based intermediation. However, the Governing Council will continue to monitor carefully the bank-based transmission channel of monetary policy and the case for mitigating measures.

Economic and monetary assessment at the time of the Governing Council meeting of 6 June 2019

Underlying global growth momentum continued to soften in early 2019, notwithstanding better than expected data in some key advanced economies. Survey-based indicators signal continued weakness in global manufacturing activity, despite some recent stabilisation at low levels, and a recent deterioration in activity in the service sector following a period of relative resilience. Global growth is projected to decelerate this year amid high and rising policy and political uncertainty, which is weighing on global investment, and the renewed intensification of trade tensions between the United States and China. While those headwinds are expected to continue to weigh on global activity and trade this year, recent policy measures are expected to provide some support thereafter. As a result, global growth is projected to decrease in 2019, but to stabilise over the medium term. Global trade is expected to weaken more significantly this year and to grow in line with economic activity in the medium term. Global inflationary pressures are expected to remain contained, while downside risks to global economic activity have intensified.

Long-term risk-free rates have declined since the Governing Council’s meeting in March 2019 amid market expectations of continued accommodative monetary policy and a resurgence of trade tensions. Non-financial equity prices have increased slightly, exhibiting some volatility, supported by low risk-free rates and improving earnings expectations. However, uncertainty related to resurgent trade tensions is weighing on the prices of risky assets. In foreign exchange markets, the euro has broadly appreciated in trade-weighted terms.

Euro area real GDP growth increased in the first quarter of 2019 to 0.4% quarter on quarter, following the slowdown in the second half of last year against the background of a weaker trend in euro area external demand. However, incoming economic data and survey information point to somewhat weaker growth in the second and third quarters of this year. This reflects the ongoing weakness in international trade in an environment of prolonged global uncertainties, which are weighing, in particular, on the euro area manufacturing sector. At the same time, the euro area services and construction sectors are showing resilience and the labour market is continuing to improve. Looking ahead, the euro area expansion will continue to be supported by favourable financing conditions, the mildly expansionary euro area fiscal stance, further employment gains and rising wages, and the ongoing – albeit somewhat slower – growth in global activity.

This assessment is broadly reflected in the June 2019 Eurosystem staff macroeconomic projections for the euro area. These projections foresee annual real GDP increasing by 1.2% in 2019, 1.4% in 2020 and 1.4% in 2021. Compared with the March 2019 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised up by 0.1 percentage points for 2019 and has been revised down by 0.2 percentage points for 2020 and by 0.1 percentage points for 2021. The risks surrounding the euro area growth outlook remain tilted to the downside on account of 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 1.2% in May 2019, after 1.7% in April, reflecting mainly lower energy and services price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months, before rising again towards the end of year. Measures of underlying inflation remain generally muted, but labour cost pressures continue to strengthen and broaden amid high levels of capacity utilisation and tightening labour markets. 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 stronger wage growth.

This assessment is also broadly reflected in the June 2019 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.3% in 2019, 1.4% in 2020 and 1.6% in 2021. Compared with the March 2019 ECB staff macroeconomic projections, the outlook for HICP inflation has been revised up by 0.1 percentage points for 2019 and revised down by 0.1 percentage points for 2020. Annual HICP inflation excluding energy and food is expected to be 1.1% in 2019, 1.4% in 2020 and 1.6% in 2021.

The annual growth of broad money and loans to the private sector increased in April 2019. Broad money (M3) growth stood at 4.7% in April 2019, after 4.6% in March. 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). At the same time, lending conditions remained favourable; the annual growth rate of loans to non-financial corporations increased to 3.9% in April 2019 from 3.6% in March. The monetary policy measures decided by the Governing Council, including 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 continue to be mildly expansionary, thereby providing support to economic activity. This profile is mainly driven by cuts in direct taxes and social security contributions in Germany and France, but also by relatively dynamic expenditure growth in several other countries.

Monetary policy decisions

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

First, the key ECB interest rates were kept unchanged. The Governing Council now expects them to remain at their present levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

Second, the Governing Council intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time past the date when it 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.

Third, regarding the modalities of the new series of quarterly targeted longer-term refinancing operations (TLTRO III), the Governing Council decided that the interest rate in each operation will be set at a level that is 10 basis points above 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 will be lower, and can be as low as the average interest rate on the deposit facility prevailing over the life of the operation plus 10 basis points.

These decisions were taken to provide the monetary accommodation necessary for inflation to remain on a sustained path towards levels that are below, but close to, 2% over the medium term. In fact, they ensure that financial conditions will remain very favourable, supporting the euro area expansion, the ongoing build-up of domestic price pressures and, thus, headline inflation developments over the medium term. At the same time, looking ahead, the Governing Council is determined to act in the event of adverse contingencies and also stands ready to adjust all of its instruments, as appropriate, to ensure that inflation continues to move towards the Governing Council’s inflation aim in a sustained manner.

External environment

Underlying global growth momentum continued to soften in early 2019, notwithstanding better than expected data in some key advanced economies. This is in line with survey-based indicators, which signal continued weakness in global manufacturing activity. Following a period of relative resilience, activity in the service sector has also deteriorated recently. Global growth is projected to decrease this year amid high and rising policy and political uncertainty, which is weighing on global investment, and the renewed intensification of trade tensions between the United States and China. While those headwinds are expected to continue to weigh on global activity and trade this year, recent policy measures are expected to provide some support thereafter. As a result, global growth is projected to decrease in 2019, but to stabilise over the medium term. Global trade is expected to weaken more significantly this year and to grow in line with economic activity in the medium term. Global inflationary pressures are expected to remain contained, while downside risks to global economic activity have intensified.

Global economic activity and trade

Underlying global growth momentum continued to soften in early 2019, notwithstanding better than expected data in some key advanced economies. In the United States, Japan and the United Kingdom, growth was better than expected in the first quarter. However, this mostly reflected temporary factors. In the United States and Japan, economic activity was supported by positive contributions from net trade, which, however, conceal negative growth rates in real imports of goods and services. Inventory building also bolstered growth, while domestic demand was subdued. In the United States, the latter was associated with the partial federal government shutdown. A stronger than expected outturn in the United Kingdom largely reflected strong government spending and significant stock-building by businesses in the run-up to the original deadline of 29 March for the country’s withdrawal from membership of the European Union (Brexit). In China, the economy remained on a path of gradual deceleration, cushioned by expansionary policy measures.

Survey-based indicators confirm a gradual weakening in growth momentum. The global composite output Purchasing Managers’ Index (PMI), excluding the euro area, softened in the first quarter of 2019 and weakened further in April and May. This is mainly related to a weaker performance across advanced economies, while emerging market economies have recorded a slightly smaller deterioration in activity. Global activity in the service sector, which had been more resilient overall in recent months, deteriorated in May, alongside a further decline in global manufacturing activity (see Chart 1).

Chart 1 Global composite output PMI (diffusion indices) 48 50 52 54 56 58 2012 2013 2014 2015 2016 2017 2018 2019 Global composite output excluding the euro area Global composite output excluding the euro area ‌ – long ‌ - ‌ term average Global manufacturing output excluding the euro area Global services excluding the euro area Sources: Markit and ECB calculations.

Notes: The latest observations are for May 2019. “Long-term average” refers to the period from January 1999 to May 2019.

Global financial conditions have been volatile in recent months. In advanced economies, they are broadly unchanged from the levels seen at the time of the March 2019 ECB staff macroeconomic projections. This stability, however, masks two distinct developments: financial conditions initially eased in response to monetary policy actions taken in the United States and other key advanced economies, but have tightened since the announcements of new tariffs between the United States and China. The latter development also contributed to a tightening of financial conditions in China and, to a lesser extent, in other emerging market economies. Financial conditions in Turkey have also tightened considerably in recent weeks owing to a renewed sharp depreciation of the lira, against the background of dwindling foreign currency reserves and rising political uncertainty. In global stock markets similar developments have been observed. Until the news about new tariffs broke, global equity prices had been rising. Since then global stock markets have declined amid increased volatility.

Global growth is projected to decelerate this year amid increasing headwinds. These headwinds include weak global manufacturing activity and trade in an environment of high and rising policy and political uncertainty. The sizeable procyclical fiscal stimulus in the United States, including lower taxes and increased expenditure, continues to provide impetus to US growth this year. In China, the slowdown in domestic demand has been cushioned by policy measures, especially those related to fiscal policy. Recent monetary policy actions across key advanced economies have supported the easing of global financial conditions and helped to contain the impact of policy uncertainties. However, the positive effect of these factors on demand seems to have been eroded by the recent escalation of the trade dispute between the United States and China.

Looking further ahead, global growth is projected to stabilise at relatively low levels over the medium term. Three key forces look set to shape the global economy over the projection horizon. First, cyclical momentum is expected to slow in key advanced economies, as capacity constraints become increasingly binding, and policy support may gradually diminish amid positive output gaps and low unemployment rates. Second, China is expected to continue its orderly transition to a more balanced, albeit weaker, growth path that is less dependent on investment and exports. Finally, growth is projected to recover in several key emerging market economies which are currently going through, or have recently experienced, deep recessions. 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, activity in the United States has remained strong, notwithstanding the headwinds related to the trade dispute with China and the less favourable external environment. The strong labour market, accommodative financial conditions and current fiscal stimulus continue to support growth, while the adverse impact of the partial federal government shutdown on domestic demand is assumed to be temporary. Overall, real GDP expanded at an annualised rate of 3.1% in the first quarter of 2019, accelerating from 2.2% in the final quarter of last year. However, the surprisingly strong growth data in the first quarter also reflected temporary factors, such as the positive contributions from inventories and falling imports. At the same time, domestic demand has declined, suggesting subdued underlying growth. Annual headline consumer price inflation picked up to 2.0% in April from 1.9% in the previous month, largely on account of increasing energy prices. Consumer price inflation excluding food and energy also increased slightly, rising to 2.1% in April. Growth is projected to gradually return to the potential growth rate of just below 2%, while consumer price inflation is expected to remain slightly above 2% over the medium term.

Growth in China has recorded a gradual slowdown. In the first quarter of 2019 annual GDP growth stabilised, supported by a positive net trade contribution as imports decreased more than exports. Looking through their volatility, the latest indicators point to stable growth momentum in the near term. A number of fiscal and monetary policy measures announced and implemented by the Chinese authorities recently are expected to cushion domestic demand and thus to deliver a smooth deceleration in activity this year. The recent escalation of the trade dispute with the United States is expected to weigh on trade, while its impact on growth is expected to be contained by policies. Looking further ahead, 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 first quarter of 2019 was 0.5% (quarter on quarter), which was better than expected, as a number of transitory factors were at play, including a large positive contribution from net exports owing to a sharp contraction in imports which exceeded the weakness in exports. Looking ahead, economic activity is expected to resume its path of moderate growth. The strong labour market and still favourable financial conditions remain supportive, although the economy is facing headwinds related to weak foreign demand, especially from China and the rest of Asia. Households are expected to frontload purchases ahead of the consumption tax hike scheduled for October 2019, which could in turn provide a temporary boost to activity over the summer months. In addition, fiscal measures aimed at counterbalancing the negative impact of the higher consumption tax are expected to support demand later in the year. Wage growth is still modest – despite the very tight labour market – and inflation expectations are stable at low levels, suggesting that inflation will remain well below the Bank of Japan’s 2% target over the medium term.

In the United Kingdom, growth rebounded in the first quarter of 2019 on the back of a fiscal boost and strong stock-building. Against the background of a last-minute extension to the long-anticipated departure date of the United Kingdom from the European Union, strong stockpiling, together with fiscal support and better than expected data on both consumption and private investment, resulted in quarterly UK real GDP growth of 0.5% in the first quarter, after a modest 0.2% in the final quarter of 2018. Net trade made a negative contribution to headline growth as imports surged at a rate rarely seen in the past 40 years, partly owing to inventory building, while exports remained flat. However, short-term indicators at the start of the second quarter suggest a continuation of the broad underlying trend of slowing growth momentum seen since the referendum on EU membership. Annual CPI inflation declined to 1.8% in the first quarter of 2019 – slightly below the Bank of England’s 2.0% target – as sharp reductions in energy prices fed through to headline inflation. Stronger domestic cost pressures from higher unit labour costs amid higher wage growth at the start of 2019 have been largely offset by the decline in import prices as the impact of the past depreciation of the pound sterling following the referendum continues to wane. CPI inflation rebounded slightly to 2.1% in April 2019 largely as a consequence of an increase in retail energy prices, as well as marked rises in air fares for the Easter period. Over the medium term growth is expected to remain below the level recorded prior to the referendum.

In central and eastern European countries, growth is projected to moderate somewhat this year. Investment growth remains strong, supported by EU funds, and consumer spending also remains robust, underpinned by the strong labour market performance. However, the slowdown in the euro area 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 remains mixed. The outlook for growth in Russia is shaped by developments in global oil markets, the execution 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. In contrast, growth in Brazil is projected to strengthen, supported by accommodative financial conditions. However, the existing fiscal constraints and uncertainties about the implementation of the current reform agenda continue to weigh on investment.

In Turkey, economic activity contracted significantly in the fourth quarter of 2018. This contraction reflects the legacy of last summer’s financial turmoil, high inflation, and procyclical monetary and fiscal policies. The economy returned to growth in the first quarter of 2019, supported by fiscal spending and higher lending by state-owned banks in the run-up to local elections in March. The expected disappearance of these supportive factors, together with the recent tightening of financial conditions, could undermine the projected gradual recovery in economic activity this year.

Global trade momentum weakened significantly at the turn of the year. It has decelerated considerably more than global activity. This is explained by weaker global investment activity and a turn in the global tech cycle[1] amid high and rising policy and geopolitical uncertainty, which in turn weighed on manufacturing output and trade. The volume of global merchandise imports, excluding the euro area, contracted by 0.6% in March in three-month-on-three-month terms, confirming subdued trade momentum in the first quarter (see Chart 2). As survey indicators signal a further deterioration in global manufacturing activity, the current weakness in global trade is likely to continue in the near term.

Bilateral trade talks between the United States and China suffered a setback in early May. The US Administration announced that it would increase the tariff rate on USD 200 billion of Chinese exports from 10% to 25%. This increase was originally scheduled for 1 January 2019, but had been postponed twice: initially for three months owing to the temporary truce agreed between the two countries in early December, and again in late February amid tangible progress in the bilateral trade talks. China retaliated by raising the tariff rate on USD 60 billion of US exports from between 5% and 10%, to between 10% and 25%. In addition, the risk of a further escalation looms large, as the US Administration has threatened to impose additional 25% tariffs on all remaining US imports from China. The prospect of a further intensification of the trade dispute between the two countries has raised global uncertainty and is weighing on investment. Moreover, the possibility that the US Administration may impose new tariffs on imports from other countries cannot be ruled out. For instance, in mid-May it announced that new tariffs of 25% on imported automobiles and auto parts, focusing primarily on imports from the EU and Japan, would be postponed for up to six months, allowing time for bilateral trade negotiations between the United States and these trading partners.

Chart 2 Surveys and global trade in goods (left-hand scale: three-month-on-three-month percentage changes; right-hand scale: diffusion indices) 44 46 48 50 52 54 56 58 -3 -2 -1 0 1 2 3 4 2012 2013 2014 2015 2016 2017 2018 2019 Global merchandise imports excluding the euro area (left ‌ - ‌ hand scale) Average global merchandise imports excluding the euro area, 1991 ‌ - ‌ 2018 (left ‌ - ‌ hand scale) Global PMI, manufacturing output excluding the euro area (right ‌ - ‌ hand scale) Global PMI, new export orders excluding the euro area (right ‌ - ‌ hand scale) Sources: Markit, CPB Netherlands Bureau for Economic Policy Analysis and ECB calculations.

Note: The latest observations are for May 2019 for the PMIs and March 2019 for global merchandise imports.

Global economic growth is projected to weaken this year, before stabilising over the medium term. According to the June 2019 Eurosystem staff macroeconomic projections, global real GDP growth (excluding the euro area) is projected to decelerate to 3.3% 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 world economic activity is projected to stabilise at 3.6%, as the (cyclical) slowdown in key advanced economies and China’s transition to a more moderate growth path are expected to be counterbalanced by a recovery in several key emerging market economies. 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 1.7%, from 3.6% in 2018. Global imports are projected to gradually increase and grow in line with global activity over the medium term. Compared with the March 2019 ECB staff macroeconomic projections, global GDP growth has been revised slightly downwards for this year. At the same time, growth in euro area foreign demand has been revised downwards more significantly over the projection horizon. From a geographical perspective, these revisions reflect weaker than expected trade prospects for China and the rest of Asia, 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 may 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 of China’s economy could be harder to counteract with efficient policy stimulus and might prove a challenge to the ongoing rebalancing process in China. Repricing in financial markets might weigh significantly on vulnerable emerging market economies. A further escalation of geopolitical tensions could also adversely affect global activity and trade.

Global price developments

While oil prices have declined since April, they have recently been volatile. Since April oil prices have declined by 13%. However, they have exhibited more pronounced volatility recently. While potential disruptions to the global oil supply owing to geopolitical tensions, particularly in the Middle East, have sent oil prices higher, concerns over trade tensions between the United States and China and their impact on global demand have lately led to downward pressure on oil prices.

In the June 2019 Eurosystem staff macroeconomic projections oil prices are expected to increase in the near term and to decline over the projection horizon. Amid short-term volatility, supply factors have continued to bolster oil prices, in particular the agreement between OPEC and other major oil producers to curb production. However, weaker global oil demand and higher than expected shale oil production in the United States could also weigh on oil prices. Consequently, the oil price assumptions underpinning the June 2019 Eurosystem staff macroeconomic projections were around 10.4% higher for this year (and 7.3% and 3.4% higher for 2020 and 2021 respectively) relative to the assumptions underpinning the March 2019 ECB staff macroeconomic projections. Since the cut-off date for the June projections, however, the price of oil has declined, with Brent crude oil standing at USD 61 per barrel on 5 June.

Global inflationary pressures remain contained. In countries belonging to the Organisation for Economic Co-operation and Development (OECD), annual headline consumer price inflation averaged 2.5% in April 2019, up from 2.3% in the previous month, owing to an increase in the contribution of the energy component (see Chart 3). Core inflation (excluding food and energy) increased slightly to 2.2% in April from 2.1% in March. Tight labour market conditions across the major advanced economies have so far translated into only moderate wage increases, suggesting that underlying inflation pressures remain subdued. Nevertheless, they should recover gradually over the projection horizon, reflecting diminishing slack.

Chart 3 OECD consumer price inflation (year-on-year percentage changes; percentage point contributions) -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2012 2013 2014 2015 2016 2017 2018 2019 Energy contribution Food contribution Contribution of all components except food and energy Inflation excluding food and energy Inflation including all components Sources: OECD and ECB calculations.

Note: The latest observations are for April 2019.

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 March 2019, global long-term risk-free rates have declined amid both market expectations of continuing accommodative monetary policy and a resurgence of trade tensions. Non-financial equity prices have increased slightly, amid some volatility, supported by the low risk-free rates and improving earnings expectations. Uncertainty related to trade tensions is weighing on the prices of risky assets. In foreign exchange markets, the euro has appreciated in trade-weighted terms.

In the review period long-term yields in both the euro area and the United States continued their decline which started in late 2018. During the period under review (7 March to 5 June 2019), the euro area ten-year risk-free overnight index swap (OIS) rate fell by 31 basis points to around 0.11% and the GDP-weighted euro area ten-year sovereign bond yield fell by 27 basis points to 0.50% (see Chart 4). Ten-year sovereign bond yields in the United States and United Kingdom also dropped, by 50 and 32 basis points respectively. The fall in global long-term yields comes on the back of communications from both the Federal Reserve System and the ECB that were perceived by market participants as suggesting continuing accommodative monetary policy. It also reflects the resurgence of trade tensions since early May.

Chart 4 Ten-year sovereign bond yields (percentages per annum) -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 01/15 04/15 07/15 10/15 01/16 04/16 07/16 10/16 01/17 04/17 07/17 10/17 01/18 04/18 07/18 10/18 01/19 04/19 GDP ‌ - ‌ weighted euro area average United Kingdom United States Germany Sources: Thomson Reuters and ECB calculations.

Notes: Daily data. The vertical grey line denotes the start of the review period on 7 March 2019. The latest observations are for 5 June 2019.

Euro area sovereign bond spreads relative to the risk-free OIS rate remained broadly stable over the review period. The spread on Portuguese debt tightened by 34 basis points in response to an improvement in the country’s fiscal position and a subsequent credit rating upgrade by Standard & Poor’s, see Chart 5. Spanish sovereign spreads decreased overall by 12 basis points, following some volatility around the April elections. Meanwhile, the spread on the debt of Italy remained volatile and elevated relative to levels seen prior to the 2018 elections; it rose by 33 basis points to 2.38 percentage points over the period under review. Overall, the spread between the GDP-weighted average of euro area ten-year sovereign bond yields and the ten-year OIS rate remained broadly stable, standing at 0.39 percentage points on 5 June.

Chart 5 Ten-year euro area sovereign bond spreads vis-à-vis the OIS rate (percentage points) -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 01/16 04/16 07/16 10/16 01/17 04/17 07/17 10/17 01/18 04/18 07/18 10/18 01/19 04/19 GDP ‌ - ‌ weighted euro area average Germany France Italy Spain Portugal Sources: Thomson Reuters and ECB calculations.

Notes: The spread is calculated by subtracting the ten-year OIS rate from the ten-year sovereign bond yield. The vertical grey line denotes the start of the review period on 7 March 2019. The latest observations are for 5 June 2019.

The euro overnight index average (EONIA) averaged −0.37% over the review period. Excess liquidity increased by around €6 billion to €1,904 billion. For further details of developments in liquidity conditions, see Box 2.

The EONIA forward curve shifted downwards over the review period. At the end of the period the curve was below zero for all horizons prior to 2024, reflecting market expectations of a prolonged period of negative interest rates (see Chart 6).

Chart 6 EONIA forward rates (percentages per annum) -0.5 0.0 0.5 1.0 1.5 2.0 2019 2020 2021 2022 2023 2024 2025 2026 2027 5 June 2019 7 March 2019 Sources: Thomson Reuters and ECB calculations.

Non-financial equity prices increased slightly in both the euro area and the United States. The share prices of euro area non-financial corporations (NFCs) and banks increased in the first part of the review period on the back of lower risk-free rates and greater optimism regarding the outlook for global trade. Euro area NFCs were also supported by improving earnings expectations. However, resurging trade tensions since early May reversed much of these gains (see Chart 7). The equity prices of euro area NFCs consequently increased by 0.5% overall, whereas bank shares decreased by 6.8%. Similar developments occurred in the United States, where NFC share prices rose by 2.3% while those of banks increased by 0.9%.

Chart 7 Euro area and US equity price indices (index: 1 January 2015 = 100) 50 75 100 125 150 175 01/15 04/15 07/15 10/15 01/16 04/16 07/16 10/16 01/17 04/17 07/17 10/17 01/18 04/18 07/18 10/18 01/19 04/19 Euro area banks Euro area NFCs US banks US NFCs Sources: Thomson Reuters and ECB calculations.

Notes: The vertical grey line denotes the start of the review period on 7 March 2019. The latest observations are for 5 June 2019.

Despite large movements, euro area corporate bond spreads stood largely unchanged at the end of the review period. Euro area corporate bond spreads initially continued their decreasing trend that started at the beginning of this year. This was halted in early May by a shift in risk sentiment that led to a strong rise in spreads. Overall, the spread between the yield on investment-grade NFC bonds and the risk-free rate declined by around 2 basis points in the review period to stand at 79 basis points (see Chart 8). Yields on financial sector debt were also little changed at the end of the review period, with their spread to the risk-free rate falling by around 3 basis points. Both spreads remained significantly below the levels observed in late 2018.

Chart 8 Euro area corporate bond spreads (basis points) 0 20 40 60 80 100 120 140 160 01/15 04/15 07/15 10/15 01/16 04/16 07/16 10/16 01/17 04/17 07/17 10/17 01/18 04/18 07/18 10/18 01/19 04/19 Financial corporate bond spreads NFC bond spreads Sources: iBoxx indices and ECB calculations.

Notes: The vertical grey line denotes the start of the review period on 7 March 2019. The latest observations are for 5 June 2019.

In foreign exchange markets, the euro appreciated 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, appreciated by 1.0%. In bilateral terms, the euro depreciated slightly against the US dollar (by 0.1%), and weakened against the Japanese yen (by 3.2%) and the Russian rouble (by 1.3%). It appreciated against the Chinese renminbi (by 2.8 %) and the pound sterling (by 3.2%). The euro also appreciated vis-à-vis the currencies of most emerging market economies.

Chart 9 Changes in the exchange rate of the euro vis-à-vis selected currencies (percentage changes) -5 0 5 10 15 20 Croatian kuna Indian rupee Brazilian real Taiwan dollar Romanian leu Danish krone Hungarian forint Indonesian rupiah South Korean won Turkish lira Russian rouble Swedish krona Czech koruna Polish zloty Japanese yen Swiss franc Pound sterling US dollar Chinese renminbi EER-38 Since 7 March 2019 Since 5 June 2018 Source: ECB.

Notes: “EER-38” is the nominal effective exchange rate of the euro against the currencies of 38 of the euro area’s most important trading partners. All changes have been calculated using the foreign exchange rates prevailing on 5 June 2019.

Economic activity

Euro area real GDP growth rose in the first quarter of 2019, following the slowdown of the second half of last year against the background of a weaker trend in euro area external demand. However, incoming data and the latest survey results point to weaker but ongoing growth momentum in the near term. The June 2019 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 1.2% in 2019, 1.4% in 2020 and 1.4% in 2021. Compared with the March 2019 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised up by 0.1 percentage points for 2019 and has been revised down by 0.2 percentage points for 2020 and by 0.1 percentage points for 2021.

Growth increased in the first quarter of 2019, largely reflecting temporary factors. Real GDP increased by 0.4%, in quarter-on-quarter terms, in the first quarter of 2019, following average growth of 0.2% in the second half of 2018 (see Box 3 for an analysis of “soft patches” in the euro area). Domestic demand remained robust in the first quarter of 2019. Notably, private consumption and fixed investment spending were the main drivers of growth, contributing 0.3 percentage points and 0.2 percentage points respectively. Changes in inventories made a negative contribution to real GDP growth in the first quarter, whereas net trade made a small positive contribution (see Chart 10). Output growth in some countries benefited from a spike in exports related to exceptionally strong import demand in the United Kingdom, in anticipation of the original Brexit date. In addition, in Germany, private consumption rebounded strongly as private car registrations surged following disruptions in car production in the second half of 2018. Private consumption was also supported by fiscal measures that became effective in the first quarter, when the measures are expected to have their biggest impact. On the supply side, growth was broadly supported across all value added components. Overall, in quarter-on-quarter terms, industrial production (excluding construction) increased by 0.8% in the first quarter of 2019, after contracting by 1.2% in the previous quarter. Production in construction expanded at a faster pace (2.0%) on account of the good weather conditions during the first few months of 2019.

Chart 10 Euro area real GDP and its components (quarter-on-quarter percentage changes and quarter-on-quarter percentage point contributions) -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2012 2013 2014 2015 2016 2017 2018 2019 GDP at market prices Private consumption Government consumption Gross fixed capital formation Net exports Changes in inventories Source: Eurostat.

Note: The latest observations are for the first quarter of 2019.

Euro area labour markets remained robust. Employment increased by 0.3% in the first quarter of 2019, unchanged from the last quarter of 2018, benefiting from robust output growth. While employment growth has slowed somewhat, on average, over the last three quarters, compared with the first half of 2018, it remains strong compared with developments in GDP growth. Average hours worked declined slightly in the first quarter of 2019. Meanwhile, productivity per person employed was unchanged in the first quarter of 2019 in quarter-on-quarter terms, after small declines in the second half of 2018.

Recent short-term labour market indicators have continued to point to positive employment growth. The euro area unemployment rate stood at 7.6% in April, down from 7.7% in March. Short-term survey indicators moderated in May but continue to suggest further employment creation in the near future.

Chart 11 Euro area employment, PMI assessment of employment and unemployment (quarter-on-quarter percentage changes; diffusion index; percentages of the labour force) 7 8 9 10 11 12 13 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 2012 2013 2014 2015 2016 2017 2018 2019 Employment (left ‌ - ‌ hand scale) PMI assessment of employment (left ‌ - ‌ hand scale) Unemployment rate (right ‌ - ‌ hand scale) Sources: Eurostat, Markit and ECB calculations.

Notes: The Purchasing Managers' Index (PMI) is expressed as a deviation from 50 divided by 10. The latest observations are for the first quarter of 2019 for employment, May 2019 for the PMI and April 2019 for the unemployment rate.

Developments in private consumption continued to be driven primarily by the recovery in the labour market and stronger household balance sheets. Private consumption rose by 0.5%, quarter on quarter, in the first quarter of 2019, following somewhat weaker growth in the last quarter of 2018. Passenger car registrations rose by 4.7%, month on month, in April, consolidating the rebound witnessed in the first quarter and broadly reaching their level of one year ago. The normalisation of car registrations is consistent with households’ stated intentions to make major purchases in the coming year. From a longer-term perspective, increasing labour income continues to support the underlying momentum in consumer spending, which is also reflected in above-average consumer confidence. In addition, the further strengthening of household balance sheets remains an important factor for steady consumption growth, as households’ creditworthiness is a key determinant of their access to credit.

The ongoing recovery in housing markets is expected to continue to contribute significantly to overall real GDP growth. Housing investment increased by 1.1% in the first quarter of 2019, reflecting its continuing recovery in many euro area countries and in the euro area as a whole. Recent short-term indicators and survey results point to positive but decelerating momentum. Construction production rose for the fourth consecutive quarter in the first quarter of 2019, increasing by 2.0%, similar to its buildings segment. Moreover, the Purchasing Managers’ Index (PMI) for construction output extended its current expansion to two and a half years in April, with a similar pattern for its residential component. At the same time, the European Commission’s construction confidence indicator decreased in May. Both the PMI indicator and the confidence indicator remained well above their long-run averages.

Business investment is expected to continue expanding, albeit at a subdued pace, in tandem with the weakening of external demand. In support of this view, according to the European Commission’s latest industrial investment survey, expectations for euro area annual investment growth in 2019 are broadly unchanged, at 4.4%, compared with the previous survey conducted in November 2018 (see Chart 12). Evidence from the survey further suggests that investment should continue to be supported by the strengthening of domestic demand, high capacity utilisation rates and favourable financing conditions. On a slightly less positive note, investment sentiment in recent quarters has been hampered by geopolitical factors, trade disputes, Brexit and vulnerabilities in China (see Box 4 entitled “Confidence and investment”).

Chart 12 Plans for real industrial investment in 2019 (volumes; annual percentage changes) -10 -5 0 5 10 15 Euro area Germany France Italy Spain European Commission survey ̶ November ‌ 2018 European Commission survey ̶ April 2019 Source: European Commission industrial investment survey.

Euro area trade has remained weak but has shown initial signs of stabilisation. According to the latest release of data from the national accounts, in the first quarter of 2019 total euro area exports increased by 0.6% in real terms, while imports increased by 0.4% on a quarterly basis. The most recent data on the monthly trade in goods have confirmed the weak performance, as nominal extra-euro area exports recorded a slight contraction in March (-0.2% month on month), while nominal extra-euro area imports have recovered somewhat after their decline in February (0.7% month on month). Goods export volumes to China recovered in March and exports to the United Kingdom surprised positively in February, driven by anticipation effects, while exports to the United States weakened during the winter. The latest survey indicators based on export orders give mixed signals.

Despite the positive reading of euro area real GDP growth in the first quarter of 2019, the most recent economic data and survey information point to somewhat weaker growth in the second and third quarters of this year. Although the impact of country and sector-specific factors appears to have dissipated to some extent, elevated global uncertainty continues to weigh on the euro area growth outlook. The European Commission’s Economic Sentiment Indicator (ESI) stood, on average, at 104.5 in April and May, below its quarterly average of 106 for the first quarter of 2019. Meanwhile, the latest composite output PMI averaged 51.6, broadly unchanged from its first quarter average. While the ESI remains above its long-term average, the PMI stands slightly below and relatively close to the threshold level of contraction.

Euro area economic growth is expected to continue at a moderate pace in the near term. The ECB’s monetary policy measures continue to support favourable lending rates, fostering economic growth in the euro area. Private consumption is supported by healthy labour markets, ongoing employment gains and household sentiment. Housing investment remains robust, while business investment is backed by favourable financing conditions and solid domestic demand. Global headwinds, however, continue to weigh on the near-term outlook for euro area growth, as the threat of increased protectionism and geopolitical factors has intensified more recently. In this context, the risks surrounding euro area growth remain tilted to the downside.

The June 2019 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 1.2% in 2019, 1.4% in 2020 and 1.4% in 2021 (see Chart 13). Compared with the March 2019 ECB staff macroeconomic projections, the outlook for real GDP growth has been revised up by 0.1 percentage points for 2019 and has been revised down by 0.2 percentage points for 2020 and by 0.1 percentage points for 2021.

Chart 13 Euro area real GDP (including projections) (quarter-on-quarter percentage changes) -0.50 -0.25 0.00 0.25 0.50 0.75 1.00 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Sources: Eurostat and the article entitled “Eurosystem staff macroeconomic projections for the euro area, June 2019”, published on the ECB’s website on 6 June 2019.

Notes: The ranges shown around the central projections are based on the differences between actual outcomes and previous projections carried out over a number of years. The width of the range is twice the average absolute value of these differences. The method used for calculating the ranges, involving a correction for exceptional events, is documented in “New procedure for constructing Eurosystem and ECB staff projection ranges”, ECB, December 2009.

Prices and costs

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.2% in May 2019, down from 1.7% in April. Looking through the recent volatility due to temporary factors, measures of underlying inflation remain generally muted, but labour cost pressures continue to strengthen and broaden amid high levels of capacity utilisation and tightening labour markets. Looking ahead, underlying inflation is expected to increase gradually over the medium term, supported by the ECB’s monetary policy measures, the ongoing economic expansion and stronger wage growth. This assessment is also broadly reflected in the June 2019 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.3% in 2019, 1.4% in 2020 and 1.6% in 2021. Compared with the March 2019 ECB staff macroeconomic projections, the outlook for HICP inflation has been revised up by 0.1 percentage points for 2019 and revised down by 0.1 percentage points for 2020. Annual HICP inflation excluding energy and food is expected to be 1.1% in 2019, 1.4% in 2020 and 1.6% in 2021.

Headline inflation decreased in May owing to weaker annual inflation rates in more volatile categories. According to Eurostat’s flash estimate, euro area annual HICP inflation fell to 1.2% in May 2019 from 1.7% in April (see Chart 14). The increase in April and subsequent decrease in May largely reflected the later timing of Easter this year and the effect this has on the year-on-year growth rates of prices of certain travel-related items. This effect is particularly evident in the evolution of HICP services inflation, which increased from 1.1% in March to 1.9% in April before falling back to 1.1% in May. HICP energy inflation declined from 5.8% in April to 3.8% in May.

Chart 14 Contributions of components to euro area headline HICP inflation (annual percentage change; percentage point contributions) -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2012 2013 2014 2015 2016 2017 2018 2019 HICP Services Non ‌ - ‌ energy industrial goods Food Energy Sources: Eurostat and ECB calculations.

Notes: The latest observations are for May 2019 (flash estimates). Growth rates for 2015 are distorted upwards owing to a methodological change (see Box 5 in Economic Bulletin, Issue 2, ECB, 2019).

Measures of underlying inflation remained generally muted. HICP inflation excluding energy and food was 0.8% in May, following 1.3% in April and 0.8% in March (see Chart 15). As with overall HICP inflation, the increase in this underlying inflation measure in April and its subsequent decrease in May also reflected the effect of the later timing of Easter. This temporary upward impact on the April inflation rate is also captured by the trimmed-mean measures included in the swathe, and it is likely that the May numbers will not change the broad picture of sideways movements in measures of underlying inflation observed in recent months. Indeed, those measures that help to abstract from such temporary effects, such as the HICP excluding energy, food, travel-related items and clothing and footwear, the Persistent and Common Component of Inflation (PCCI) and the Supercore indicator were all unchanged in April (the latest available data).[2] Looking ahead, measures of underlying inflation are expected to increase gradually, especially driven by the robust wage growth and the pick-up seen in producer output price inflation.

Chart 15 Measures of underlying inflation (annual percentage changes) 0.0 0.5 1.0 1.5 2.0 2.5 3.0 2011 2012 2013 2014 2015 2016 2017 2018 2019 HICP excluding energy and food HICP excluding energy, food, travel ‌ - ‌ related items and clothing and footwear Supercore PCCI Sources: Eurostat and ECB calculations.

Notes: The latest observations are for May 2019 (flash estimate) for HICP excluding energy and food and for April 2019 for all the other measures. The range of measures of underlying inflation consists of the following: HICP excluding energy; HICP excluding energy and unprocessed food; HICP excluding energy and food; HICP excluding energy, food, travel-related items and clothing; the 10% trimmed mean; the 30% trimmed mean; and the weighted median of the HICP. Growth rates for HICP excluding energy and food for 2015 are distorted upwards owing to a methodological change (see Box 5 in Economic Bulletin, Issue 2, ECB, 2019).

Price pressures in the later stages of the non-energy industrial goods supply chain remained well above their historical average, but eased slightly in the earlier stages. Producer price inflation for non-food consumer goods sold in the euro area declined slightly to 0.9% in April from 1.0% March, although this was still well above its historical average of 0.55%. Its rise from a trough of -0.2% in December 2016 has been broad-based across the constituent manufacturing sub-sectors, suggesting some robustness. The corresponding import price inflation continued on a steady rise to 1.5% in March from a recent low of 0.3% in December, largely reflecting the impact of the recent depreciation of the euro effective exchange rate. This may have counterbalanced somewhat weaker global price pressures, with global Producer Price Index (PPI) inflation excluding energy easing further in March to 3.3%, down from its peak of 4.8% in September 2018.

Wage growth remained robust, underscoring the build-up in domestic cost pressures. Annual growth in compensation per employee was 2.2% in the first quarter of 2019, unchanged from the fourth quarter of 2018 and above its long-term average (see Chart 16). Annual growth in negotiated wages in the euro area was 2.2% in the first quarter of 2019, also unchanged from the fourth quarter of 2018. In contrast to the wage drift, negotiated wage growth is more persistent, reacting gradually to cumulative changes in the unemployment rate. The outlook for continued strong negotiated wage growth ahead largely rests on some longer-term agreements (in some cases up to 2020) and should support a robust pace of growth in compensation per employee throughout 2019.

Chart 16 Contributions of components of compensation per employee (annual percentage change; percentage point contributions) -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 2012 2013 2014 2015 2016 2017 2018 2019 Compensation per employee growth Negotiated wages Social security contributions Wage drift Sources: Eurostat and ECB calculations.

Note: The latest observations are for the first quarter of 2019.

Market measures of longer-term inflation expectations have fallen somewhat, while survey-based expectations have remained stable. The five-year inflation-linked swap rate five years ahead stood at 1.29% on 5 June 2019, eight basis points below the rate which prevailed at the time of the April Governing Council meeting (see Chart 17). 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 close to, but below 2%. The risk-neutral probability of negative average inflation over the next five years implied by inflation options markets is negligible, which suggests that markets currently consider the risk of deflation to be very low. Longer-term inflation expectations as measured by surveys remained stable at rates below, but close to, 2%. In the ECB Survey of Professional Forecasters for the second quarter of 2019, longer-term inflation expectations remained at 1.8%, while in the April Consensus Economics and Euro Zone Barometer surveys longer-term inflation expectations remained at 1.9%.

Chart 17 Measures of inflation expectations (annual percentage changes) 0.0 0.5 1.0 1.5 2.0 2.5 3.0 2012 2013 2014 2015 2016 2017 2018 2019 SPF longer ‌ - ‌ term One ‌ - ‌ year inflation ‌ - ‌ linked swap rate, four years ahead Five ‌ - ‌ year inflation ‌ - ‌ linked swap rate, five years ahead Consensus Economics longer ‌ - ‌ term Sources: ECB Survey of Professional Forecasters (SPF), Consensus Economics, Thomson Reuters and ECB calculations.

Notes: In the SPF, the longer-term horizon refers to a calendar year four to five years ahead of the survey date, while in the Consensus Economics survey the longer-term horizon refers to the average for a period five to ten years ahead of the survey date. The latest observations are for the second quarter of 2019 for the SPF, for April 2019 for Consensus Economics and for 5 June 2019 for inflation-linked swap rates.

The June 2019 Eurosystem staff macroeconomic projections expect underlying inflation to increase gradually. On the basis of the information available at mid-May, these projections expect headline HICP inflation to average 1.3% in 2019, 1.4% in 2020 and 1.6% in 2021, compared with 1.2%, 1.5% and 1.6% respectively in the March 2019 ECB staff macroeconomic projections (see Chart 18). These revisions are largely explained by the energy component, which is revised upwards markedly for 2019, due to stronger growth in oil prices, and downwards for 2020, due to a more steeply downward sloping profile for oil price futures. HICP inflation excluding energy and food is projected to follow an upward path, supported by the more gradual but continued economic recovery and the tightening labour market conditions, leading to higher domestic cost pressures. HICP inflation excluding energy and food is expected to rise from 1.1% in 2019 to 1.4% in 2020 and 1.6% in 2021. This profile represents a small downward revision for 2019, mainly reflecting weaker than expected data outturns so far this year.

Chart 18 Euro area HICP inflation (including projections) (annual percentage changes) -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Sources: Eurostat and the article entitled “June 2019 Eurosystem staff macroeconomic projections for the euro area”, published on the ECB’s website on 6 June 2019.

Notes: The latest observations are for the first quarter of 2019 (data) and the fourth quarter of 2021 (projection). The ranges shown around the central projections are based on the differences between actual outcomes and previous projections carried out over a number of years. The width of the ranges is twice the average absolute value of these differences. The method used for calculating the ranges, involving a correction for exceptional events, is documented in the “New procedure for constructing Eurosystem and ECB staff projection ranges”, ECB, December 2009. The cut-off date for data included in the projections was 22 May 2019.

Money and credit

The annual growth of broad money and loans to the private sector increased in April 2019. 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). At the same time, bank funding and lending conditions remained favourable, also reflecting the monetary policy measures announced in March and June. Net issuance of debt securities by NFCs rebounded in the first quarter of 2019 after declining in the fourth quarter of 2018, amid an improvement in bond market conditions and, until April, the decline in the cost of market-based debt financing.

Broad money growth edged up in April, returning to its growth rate at the end of 2017. The annual growth rate of M3 increased to 4.7% in April 2019 from 4.6% in March (see Chart 19), supported by lower opportunity costs. In this respect, M3 growth remained resilient in the face of the fading out of the mechanical contribution of the APP, implying that the latter had a smaller positive impact. M3 growth had moderated from late 2017 until a recent low in August 2018, as the net asset purchases were scaled down. The narrow money aggregate M1, which includes the most liquid components of M3, remained the main contributor to broad money growth. The annual growth rate of M1 was broadly stable in April at 7.4%, as opposed to 7.5% in March, confirming the halt of the downward trend observed since late 2017. Given the leading properties of real M1 with respect to real GDP growth, this development is consistent with a stabilisation in economic activity going forward.[3]

Chart 19 M3, M1 and loans to the private sector (annual percentage changes; adjusted for seasonal and calendar effects) -4 -2 0 2 4 6 8 10 12 2012 2013 2014 2015 2016 2017 2018 2019 M3 M1 Loans to the private sector Source: ECB.

Notes: Loans are adjusted for loan sales, securitisation and notional cash pooling. The latest observation is for April 2019.

Overnight deposits, the main component of M1, continued to grow at a robust annual pace. The annual growth rate of overnight deposits remained unchanged at 7.8% in April, reflecting the stable annual growth rate of overnight deposits held by households, while the corresponding rate for NFCs declined. Moreover, notwithstanding some short-term volatility, the growth in currency in circulation has followed its long-established trend, thus speaking against any material substitution of cash for deposits in an environment of very low or negative interest rates for the euro area as a whole. The contribution of short-term deposits other than overnight deposits (i.e. M2 minus M1) became positive for the first time since late 2013, continuing the upward trend observed in recent quarters and supported by lower opportunity costs of holding M3. Marketable instruments (i.e. M3 minus M2) continued to contribute negatively to M3 growth as a result of the relatively low remuneration of these instruments.

The decreasing mechanical contribution of the APP to M3 growth has been largely offset, from the counterparts’ perspective, by positive contributions from credit to the private sector and, recently, from external monetary inflows (see Chart 20). 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, decreased further (see the red parts of the bars in Chart 20). While credit to the private sector remained the main source of money creation (see the blue parts of the bars in Chart 20), the lower contribution of the APP has been replaced during recent months by external monetary flows (see the yellow parts of the bars in Chart 20). The increasing contribution from net external assets reflects the higher interest of foreign investors in euro area assets.

Chart 20 M3 and its counterparts (annual percentage changes; contributions in percentage points; adjusted for seasonal and calendar effects) -6 -4 -2 0 2 4 6 8 10 2012 2013 2014 2015 2016 2017 2018 2019 M3 Net external assets General government debt securities held by the Eurosystem Credit to general government from MFIs excluding the Eurosystem Credit to the private sector Inflows from longer ‌ - ‌ term financial liabilities and other counterparts Source: ECB.

Notes: Credit to the private sector includes MFI loans to the private sector and MFI holdings of debt securities issued by the euro area private non-MFI sector. As such, it also covers purchases by the Eurosystem of non-MFI debt securities under the corporate sector purchase programme. The latest observation is for April 2019.

Loan growth has broadly followed the slowdown in economic activity but picked up somewhat in April. The annual growth rate of MFI loans to the private sector (adjusted for loan sales, securitisation and notional cash pooling) edged up to 3.4% in April, from 3.2% in March (see Chart 19). This was mainly owing to the increase in the annual growth rate of loans to NFCs to 3.9% in April, from 3.6% in March. Looking beyond short-term volatility, NFC loan growth has moderated somewhat, but remained relatively close to its September 2018 peak of 4.3%. This is in line with its lagging cyclical pattern with respect to real economic activity and the slowdown in aggregate demand observed over the course of 2018. The moderation was largely driven by diminished loan demand owing to firms’ lower financing needs. By contrast, bank lending and bond market conditions remained favourable (see below), suggesting that supply forces are not weighing on credit dynamics given the ample degree of monetary policy accommodation. Loan growth for firms was characterised by considerable heterogeneity across countries (see Chart 21). The annual growth rate of loans to households increased slightly to 3.4% in April, from 3.3% in March, also characterised by cross-country heterogeneity (see Chart 22). The overall gradual expansion of loans to households continued to be driven by both consumer credit and housing loans, the latter growing moderately in net terms by historical standards for the euro area as a whole. At the same time, housing loan growth and house price developments are also heterogeneous across countries.

Chart 21 MFI loans to NFCs in selected euro area countries (annual percentage changes) -15 -10 -5 0 5 10 15 20 2012 2013 2014 2015 2016 2017 2018 2019 Euro area Germany France Italy Spain Cross ‌ - ‌ country dispersion Source: ECB.

Notes: Loans are adjusted for loan sales, securitisation and notional cash pooling. The cross-country dispersion is calculated on the basis of minimum and maximum values using a fixed sample of 12 euro area countries. The latest observation is for April 2019.

Chart 22 MFI loans to households in selected euro area countries (annual percentage changes) -10 -5 0 5 10 2012 2013 2014 2015 2016 2017 2018 2019 Euro area Germany France Italy Spain Cross ‌ - ‌ country dispersion Source: ECB.

Notes: Loans are adjusted for loan sales and securitisation. The cross-country dispersion is calculated on the basis of minimum and maximum values using a fixed sample of 12 euro area countries. The latest observation is for April 2019.

Banks’ debt funding conditions have improved further. In April, the composite cost of debt financing for euro area banks decreased further, down from its recent peak in January 2019 and returning to its level in February 2018 (see Chart 23). This development was driven mainly by a considerable decline in bank bond yields. Still, compared with deposits, bank bonds remained the more expensive source of funding, accounting for a limited share in banks’ overall debt funding. In addition, euro area banks’ deposit rates remained broadly stable in April. The improvement in banks’ debt funding costs was widespread across the largest euro area countries. While deposit rates remained broadly unchanged across these countries, bank bond yields declined considerably in April. In addition, euro area banks reported improved access to funding in the first quarter of 2019 in their responses to the ECB’s bank lending survey, 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 April, euro area banks’ loan-deposit margins decreased somewhat for new business. Simultaneously, the compression of loan-deposit margins is ongoing for the rates on outstanding loans in countries with a high reliance on fixed-rate contracts, indicating a gradual repricing of old loan contracts at new, lower rates. The compression of loan-deposit margins as such exerts a dampening impact on bank profitability, which is however compensated 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 have remained favourable, reflecting the ECB’s accommodative monetary policy stance and the strengthening of banks’ balance sheets. At the same time, despite banks’ progress in consolidating their balance sheets, for instance by reducing non-performing loans, the level of euro area bank profitability remains low.

Chart 23 Banks’ composite cost of debt financing (composite cost of deposit and unsecured market-based debt financing; percentages per annum) 0 1 2 3 4 5 6 2012 2013 2014 2015 2016 2017 2018 2019 Euro area Germany France Italy Spain Sources: ECB, Markit iBoxx and ECB calculations.

Notes: The composite cost of deposits is calculated as an average of new business rates on overnight deposits, deposits with an agreed maturity and deposits redeemable at notice, weighted by their corresponding outstanding amounts. The latest observation is for April 2019.

Bank lending rates for NFCs and households remained historically low. In April 2019 the composite bank lending rate for NFCs (see Chart 24) declined to 1.62%, matching its historical low level of May 2018. More favourable bank funding costs as well as continued strong competitive pressures had a dampening impact on NFC bank lending rates. In addition, low credit risk for NFCs on aggregate, as indicated by low expected default frequencies, also contributed to keeping lending rates at low levels. The composite bank lending rate for housing loans declined to 1.75% in April, reaching a new historical low (see Chart 25). Competitive pressures as well as more favourable bank funding costs exerted a dampening impact on lending rates for euro area 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 April 2019 composite lending rates on loans to NFCs and households fell by around 130 and 115 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 primarily granted to small firms), was particularly significant in those euro area countries that were 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.

Chart 24 Composite lending rates for NFCs (percentages per annum; three-month moving averages) 0.0 0.4 0.8 1.2 1.6 2.0 0 1 2 3 4 5 2012 2013 2014 2015 2016 2017 2018 2019 Euro area Germany France Italy Spain Cross ‌ - ‌ country standard deviation (right ‌ - ‌ hand scale) Source: ECB.

Notes: The indicator for the total cost of bank borrowing is calculated by aggregating short and long-term rates using a 24-month moving average of new business volumes. The cross-country standard deviation is calculated using a fixed sample of 12 euro area countries. The latest observation is for April 2019.

Chart 25 Composite lending rates for house purchase (percentages per annum; three-month moving averages) 0.0 0.2 0.4 0.6 0.8 1.0 0 1 2 3 4 5 2012 2013 2014 2015 2016 2017 2018 2019 Euro area Germany France Italy Spain Cross ‌ - ‌ country standard deviation (right ‌ - ‌ hand scale) Source: ECB.

Notes: The indicator for the total cost of bank borrowing is calculated by aggregating short and long-term rates using a 24-month moving average of new business volumes. The cross-country standard deviation is calculated using a fixed sample of 12 euro area countries. The latest observation is for April 2019.

The annual flow of total external financing to euro area NFCs is estimated to have moderated in the first quarter of 2019. This reflected the moderation in bank lending as well as continued low issuance of listed shares, whereas the net issuance of debt securities was relatively strong. Still, compared with the previous growth slowdown episode in 2015-2016, NFC debt financing flows (based on MFI loans, debt securities issuance and non-MFI loans) were higher. This is consistent with favourable debt financing conditions and stronger corporate balance sheets. Overall, given the typically lagged reaction of NFC external financing to economic activity, the recent moderation in NFC external financing is consistent with the weakening of economic activity in 2018 and the resultant lower financing needs of firms.

In the first quarter of 2019, the net issuance of debt securities by NFCs rebounded strongly from the negative level recorded in the last quarter of 2018. The main driver of the positive net flow of NFC debt securities issued in the first quarter of 2019 is most likely the postponed issuance in the last quarter of 2018 that was related to the deterioration in the economic outlook and the increase in the spreads of the bonds issued by NFCs, in the context of broader risk aversion in the market. The rapid decline of the cost of market-based debt financing since the end of 2018 prompted a rebound in NFC net issuance of debt securities. Taking a somewhat longer perspective, the annual net issuance flows for March 2019 were above those in December 2018 – which was the lowest reading since May 2016 (see Chart 26) – and in line with a gradual stabilisation that started at the beginning of 2019. Market data suggest that the net issuance of debt securities by both investment-grade and high-yield issuers in April and May 2019 was much more muted than it was in the first quarter of 2019. The net issuance of listed shares continued to weaken in the first quarter of 2019, reflecting a series of negative net monthly flows that started in November 2018.

Chart 26 Net issuance of debt securities and quoted shares by euro area NFCs (annual flows in EUR billions) -25 0 25 50 75 100 125 150 12/11 06/12 12/12 06/13 12/13 06/14 12/14 06/15 12/15 06/16 12/16 06/17 12/17 06/18 12/18 Debt securities Quoted shares Source: ECB.

Notes: Monthly figures based on a 12-month rolling period. The latest observation is for March 2019.

In April 2019, the cost of financing for NFCs declined further compared to its end-2018 level and reached its historical minimum. In April, the overall nominal cost of external financing for NFCs, comprising bank lending, debt issuance in the market and equity finance, stood at 4.4%. This is seven basis points lower than it was in March 2019, and a new historical low. Although the cost of financing is estimated to have increased slightly in May, it remains substantially lower than the level seen in mid-2014, when market expectations regarding the introduction of the public sector purchase programme began to emerge.

According to the latest Survey on the Access to Finance of Enterprises, SMEs in the euro area continued to signal support for accommodative financing conditions while indicating some concerns about past developments in their business environment. Fewer SMEs indicated increases in the availability of external sources of finance, despite a positive willingness of banks to extend credit. Furthermore, an increasing share of SMEs across most euro area countries perceived the macroeconomic outlook as an impediment to their access to external finance. Nevertheless, as in the previous survey, they ranked access to finance as their lowest concern, although significant cross-country differences still exist. The percentage of distressed SMEs in the euro area has remained broadly unchanged at around 3%, far from its historical peak of more than 14% in the second half of 2012. On balance, a declining but still sizeable share of SMEs reported higher turnover in a context of unchanged profits. Competition, difficulties in finding customers as well as growing labour and other costs (for material, energy and interest expenses) may have all weighed on profits.

Fiscal developments

The euro area fiscal stance is projected to continue to be mildly expansionary, thus providing support to economic activity. At the same time, countries where government debt is high need to continue rebuilding fiscal buffers. All countries should reinforce their efforts to achieve a more growth-friendly composition of public finances. Likewise, the transparent and consistent implementation of the European Union’s fiscal and economic governance framework over time and across countries remains essential to bolster the resilience of the euro area economy.

Following an improvement last year, the euro area general government budget deficit is projected to deteriorate in 2019 and remain stable in the following two years. [4] The general government deficit ratio for the euro area stood at 0.5% of GDP in 2018, compared with 1.0% of GDP in 2017. The improvement in 2018 was mainly the result of favourable cyclical conditions and declining interest payments. The improvement is likely to be reversed this year on account of a significantly lower cyclically adjusted primary balance. The higher deficit is also expected to persist over the following two years (see Chart 27).

The outlook for the euro area general government deficit ratio has improved marginally over the whole projection horizon compared with the March 2019 ECB staff projections. The lower deficit mainly reflects a smaller deterioration in the cyclically adjusted primary balance.

Chart 27 Budget balance and its components (percentage of GDP) -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2017 2018 2019 2020 2021 Cyclically adjusted primary balance (net of financial sector support) Cyclical component Interest payments Budget balance Financial sector support Sources: ECB and June 2019 Eurosystem staff macroeconomic projections.

Notes: The data refer to the aggregate general government sector of the euro area.

The aggregate fiscal stance for the euro area is assessed to have been neutral in 2018 but is projected to be mildly expansionary from 2019 onwards. [5] This profile is mainly driven by cuts to direct taxes and social security contributions in both Germany and France but it is also a result of relatively dynamic expenditure growth in several other countries.

The decline in the euro area aggregate public debt-to-GDP ratio is projected to continue at a slower pace. According to the June 2019 Eurosystem staff macroeconomic projections, the aggregate general government debt-to-GDP ratio in the euro area is expected to decline from 85.1% of GDP in 2018[6] to 80.6% of GDP in 2021. The projected reduction in the government debt ratio is supported by both a negative interest rate-growth rate differential[7] and continued primary surpluses (see Chart 28), although deficit-debt adjustments are expected to offset some of these effects. Over the projection horizon, the debt ratio is projected to fall or increase only slowly in all euro area countries but it will continue to far exceed the reference value of 60% of GDP in a number of countries. Compared with the March 2019 projections, the decline in the aggregate euro area debt-to-GDP ratio is expected to be somewhat more pronounced, with the projected ratio for 2021 being revised down by 0.5 percentage points. This is mainly due to slightly higher primary surplus projections coupled with small downward revisions to the deficit-debt adjustment.

Chart 28 Drivers of change in public debt (percentage points of GDP) -6 -5 -4 -3 -2 -1 0 1 2018 2019 2020 2021 2019-21 Cumulative change Primary balance ( ‌ - ‌ ) Deficit ‌ - ‌ debt adjustment Interest ‌ - ‌ growth differential Consolidated gross debt Sources: ECB and June 2019 Eurosystem staff macroeconomic projections.

Notes: The data refer to the aggregate general government sector of the euro area.

Countries need to ensure that their fiscal policies fully comply with the Stability and Growth Pact. In particular, countries where government debt is high need to set their debt ratio on a declining path. At the same time, all countries should increase efforts to achieve a more growth-friendly composition of public finances.

Boxes

The decrease in euro area net financial outflows in 2018: foreign direct investment retrenchment and portfolio investment slowdown

Prepared by Michael Fidora and Martin Schmitz

In 2018 the financial account of the euro area balance of payments recorded net outflows of 2.7% of euro area GDP (see Chart A). The decrease in net financial outflows, from 3.4% of GDP in 2017, is in line with the narrowing of the euro area current account surplus recorded in 2018 and partly reflects the stepwise reduction in the net purchases of the Eurosystem’s asset purchase programme (APP). The net outflows continued to be driven by portfolio investment in debt securities as well as – to a lesser extent – financial derivatives, foreign direct investment (FDI) and reserve assets. At the same time, the euro area recorded net inflows of portfolio investment in equity and other investment (largely comprising currency, loans and deposits).

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Liquidity conditions and monetary policy operations in the period from 30 January to 16 April 2019

Prepared by Iwona Durka and Annette Kamps

This box describes the ECB’s monetary policy operations during the first and second reserve maintenance periods of 2019, which ran from 30 January to 12 March 2019 and from 13 March to 16 April 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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Definitions and characteristics of soft patches in the euro area

Prepared by Mattia Duma, Magnus Forsells and Neale Kennedy

Following an exceptionally strong performance in 2017, growth slowed in 2018, raising the question of whether this was just a temporary “soft patch” or should have been seen as pointing to a more prolonged period of weakness. The term “soft patch” is used widely in the media and elsewhere to describe a temporary period of slower growth during an expansionary phase characterised by higher trend growth rates.[8] However, there appears to have been relatively little analysis of such periods, particularly for the euro area.

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Confidence and investment

Prepared by Malin Andersson and Benjamin Mosk

Economic agents’ confidence and developments in the real economy are intrinsically linked. [9] Periods of high confidence could, per se, spur activity, while currently lower confidence could reinforce the magnitude and persistence of the ongoing economic slowdown in the euro area. In terms of the expenditure components of GDP, business investment is particularly affected by changes in confidence and uncertainty, as firms may postpone their investment plans and choose to “wait and see” in times of high uncertainty.[10] This box looks at the potential propagation effects of lower confidence on investment in recent times.

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Rent inflation in the euro area since the crisis

Prepared by Moreno Roma

Rent inflation has recently strengthened, rather than mitigated, the still relatively subdued developments in services and underlying inflation in the euro area. Having been hovering around 1¼% since January 2018, rent inflation has, on balance, stayed below the inflation rate for services as a whole (see Chart A). While this was the case for most of the pre-crisis period[11], it appears more striking now, as rent inflation is typically considered to be a more resilient inflation component that is relatively higher in periods when other components of HICP inflation tend to be low. These developments are also interesting in the context of public debates, in many euro area countries, about strong rent increases, and against the background of the sustained increases in euro area house prices over recent years. This box puts recent developments in euro area rent inflation into perspective. As housing and rental markets have remained heterogeneous, this box also looks at developments across euro area countries.

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Articles

The euro area labour market through the lens of the Beveridge curve

Prepared by Agostino Consolo and António Dias da Silva

In this article we look at the euro area labour market using the framework underlying the Beveridge curve, which captures the negative relationship between the unemployment rate and the job vacancy rate. The Beveridge curve shows that, at a given moment in time, there are jobs vacant and people unemployed, while the shape and the position of the curve provide important information about the functioning of the labour market. There are two key concepts associated with the Beveridge curve: labour market tightness and matching efficiency. Labour market tightness is the number of vacant posts per each unemployed person and matching efficiency reflects the market’s ability to match individuals to jobs. We analyse the importance of these two concepts for wage developments using a simple version of the search and matching model, where unemployment, wages and vacancies are jointly determined and the Beveridge curve features prominently.[12] First, we derive two aggregate measures that encapsulate the changes in the vacancy -unemployment space: labour market tightness and matching efficiency. Second, we look at the information content behind market tightness and job matching efficiency to analyse the euro area labour market and its cyclical conditions. Third, aggregate measures of labour market tightness and efficiency are used in a standard wage Phillips curve equation to measure their marginal impact. The results support the view that labour market tightness and labour market efficiency both play a role in explaining wage developments. However, the quantitative implications for wages differ only marginally from those of the standard Phillips curve approach. Overall, labour market efficiency provides an important qualitative margin of labour market functioning that is not captured in standard wage Phillips curve specifications.

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Drivers of underlying inflation in the euro area over time: a Phillips curve perspective

Prepared by Elena Bobeica and Andrej Sokol

In this article we review the evolution of euro area HICP inflation excluding energy and food since the Great Financial Crisis through the lens of the Phillips curve. This period is particularly interesting, as the euro area experienced two recessions (in 2008-2009 and 2011-2014) and a protracted episode of low inflation from 2013 onwards. We estimate a large set of Phillips curve models for the euro area and review the interpretation of inflation developments that they provide over time. We find that our models can account for much of the weakness in underlying inflation between 2013 and mid-2017, but that they cannot account for the weakness in underlying inflation towards the end of our sample.

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Statistics

Statistical annex