Update on economic and monetary developments

Summary

The incoming information that has become available since the Governing Council’s decision to end net asset purchases in December 2018 has continued to be weaker than expected on account of softer external demand and some country and sector-specific factors. In particular, the persistence of uncertainties relating to geopolitical factors and the threat of protectionism is weighing on economic sentiment.

At the same time, supportive financing conditions, favourable labour market dynamics and rising wage growth continue to underpin the euro area expansion and gradually rising inflation pressures. This underlying strength of the economy supports the Governing Council’s confidence in the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. Nevertheless, significant monetary policy stimulus remains essential to support the further build-up of domestic price pressures and headline inflation developments over the medium term. This will be provided by the Governing Council’s forward guidance on the key ECB interest rates, reinforced by the reinvestments of the sizeable stock of acquired assets. The Governing Council confirmed that it 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.

The global economic growth momentum has slowed recently amid geopolitical uncertainties and vulnerabilities in emerging markets. Global trade decelerated towards the end of 2018 as downside risks related to unresolved trade disputes remained prominent and growth in emerging markets slowed down. While financial conditions are favourable overall, the weaker global growth momentum has fuelled stock market volatility. A more accommodative monetary policy stance has been taken in China in the light of the slowing growth momentum.

Euro area government bond yields declined somewhat as global risk-free rates decreased and sovereign bond spreads in the euro area remained stable. Despite heightened intra-period volatility, equity prices in the euro area stayed, overall, broadly unchanged. Similarly, yield spreads on corporate bonds increased only modestly. In foreign exchange markets, the euro depreciated in trade-weighted terms.

Euro area real GDP increased by 0.2%, quarter on quarter, in the third quarter of 2018, following growth of 0.4% in the previous two quarters. Incoming data have continued to be weaker than expected resulting from a slowdown in external demand which was compounded by several country and sector-specific factors. While the impact of some of these factors is expected to fade, the near-term growth momentum is likely to be weaker than previously anticipated. Looking ahead, the euro area expansion will continue to be supported by favourable financing conditions, further employment gains and rising wages, lower energy prices, and the ongoing – albeit somewhat slower – expansion in global activity.

Euro area annual HICP inflation declined to 1.6% in December 2018, from 1.9% in November, reflecting mainly lower energy price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline further over the coming months. Measures of underlying inflation remain generally muted, but labour cost pressures are continuing 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 rising wage growth.

Overall, the risks surrounding the euro area growth outlook have moved to the downside on account of the persistence of uncertainties related to geopolitical factors and the threat of protectionism, vulnerabilities in emerging markets and financial market volatility.

The monetary analysis shows that broad money (M3) growth decreased to 3.7% in November 2018, after 3.9% in October. M3 growth continues to be backed by bank credit creation. The narrow monetary aggregate M1 remained the main contributor to broad money growth. The annual growth rate of loans to non-financial corporations stood at 4.0% in November 2018, after 3.9% in October, while the annual growth rate of loans to households remained broadly unchanged at 3.3%. The euro area bank lending survey for the fourth quarter of 2018 suggests that overall bank lending conditions remained favourable, following an extended period of net easing, and demand for bank credit continued to rise, thereby underpinning loan growth.

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

Based on this assessment, the Governing Council decided to keep the key ECB interest rates unchanged and continues to expect them to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

Regarding non-standard monetary policy measures, the Governing Council confirmed that the Eurosystem will continue to reinvest, in full, the principal payments from maturing securities purchased under the asset purchase programme 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.

External environment

Economic indicators signal a moderation in global growth momentum. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area weakened in late 2018 (see Chart 1), mainly owing to a continued deceleration in global manufacturing activity. The services sector remained more resilient than manufacturing, notwithstanding some volatility in the figures. Consumer confidence has declined recently, albeit from high levels.

Downside risks to global activity have been increasing and a further escalation of trade disputes could weigh on global growth. While the postponement of further tariff increases by the United States and China has sent a positive signal, considerable uncertainty remains as to whether the negotiations will lead to a significant de-escalation of US-Chinese trade tensions. Other downside risks relate to a faster tightening of global financial conditions and broader stress in emerging markets, uncertainties regarding China’s economic prospects, as well as political and geopolitical uncertainties, including risks related to Brexit.

Financial conditions remain accommodative overall, while concerns over US and global economic activity have fuelled stock market volatility. In China, fiscal policy and monetary policy have eased in response to a weakening, in particular, of the manufacturing sector. Market expectations of further interest rate increases in the United States have eased somewhat, amid a further decline in Treasury yields, partly reflecting developments in term premia. Looking ahead, the Federal Open Market Committee (FOMC) is proceeding with its gradual policy normalisation, albeit against a more cautious economic outlook and a slightly lower interest rate path projection.

Global trade momentum decelerated towards the end of 2018. Global merchandise imports weakened in October, while in December the global PMI for new export orders pointed, for the fourth consecutive month, to a contraction (see Chart 2). High frequency trade data for China weakened considerably towards the end of 2018, possibly signalling that the trade tensions between the United States and China are affecting manufacturing sentiment in both economies and are adversely impacting global trade growth.

Global inflation slowed in November. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) moderated to 2.7% in November, largely as a result of easing energy prices, while inflation excluding food and energy decreased marginally to 2.2%. Global inflationary pressures are expected to remain contained. Wage growth in advanced economies continues to be moderate, despite a tightening of labour markets and rising capacity constraints.

Oil markets have remained broadly stable. Oil prices declined in the fourth quarter of 2018, mainly on account of oversupply fears related to the waivers on the US sanctions on Iranian oil exports, coupled with continued high production growth in the United States. These effects initially outweighed the possible price effects of production cuts by OPEC and a group of allied oil-producing nations, particularly because market uncertainty persisted regarding the cuts agreed on 7 December 2018. However, prices recovered after data releases indicated lower than expected production levels, and Brent crude oil prices stood at USD 61 per barrel on 22 January. Non-oil commodity prices have increased slightly, mainly on the back of food price increases.

The US economy recorded strong growth in 2018, in the context of a pro-cyclical fiscal stimulus, but lower confidence and weaker than expected data have clouded the growth outlook. Real GDP growth expanded at an annualised rate of 3.4% in the third quarter of 2018 – well above potential – albeit slowing from 4.2% in the previous quarter on the back of declining net exports and decelerating private fixed investment. The US government shutdown has added to the uncertainty generated by US trade policy in respect of China and is (temporarily) weighing on US economic activity in the near term. Headline consumer price inflation declined to 1.9% in November due to a sharp deceleration in energy prices, while average hourly earnings remained strong. Against this background, the FOMC raised the federal funds rate target range at its December 2018 meeting by 25 basis points, as expected, and slightly lowered its projections for GDP growth and core inflation for the next years.

In Japan, real GDP for the fourth quarter of 2018 is set to return to positive growth, but inflation remains weak. Volatility in GDP in 2018 was mainly due to the impact of natural disasters and extreme weather conditions. Looking ahead, the economy is expected to remain on a moderate growth path, supported by highly accommodative monetary policy and the domestic capital expenditure cycle. The reflation momentum in the economy has weakened, with inflation excluding energy and food declining marginally due to the recent softening of oil prices and the appreciation of the yen.

In the United Kingdom, growth looks set to decline after a robust outturn in the third quarter of 2018. The strong quarter-on-quarter growth of 0.6% in the third quarter reflected a temporary boost to consumption and public investment, as well as a strong rebound in exports. However, business investment fell for the third consecutive quarter. Overall, activity is expected to remain muted in the medium term. Annual CPI inflation decreased slightly to 2.1% in December, resulting in a fourth quarter average of 2.3%, following strong declines in previous months.

The Chinese economy is losing growth momentum, with the manufacturing sector in particular showing signs of weakening. In December 2018, the manufacturing PMI dropped below 50 for the first time since 2017, while the services sector – less exposed to the US trade tensions – was more resilient. The People’s Bank of China enacted new policies to cushion the slowdown, including a 100-basis point reduction in the required reserve ratio in early January and a new lending facility to support small firms in December. New fiscal policy measures are also expected, although fiscal spending by local governments may face constraints. Annual headline CPI inflation fell to 1.9% in December, reflecting a lower contribution from non-food items, while core inflation remained steady. Producer price index inflation decelerated sharply to 0.9% in the same month in response to lower oil and commodity prices, and also to the slowdown in Chinese manufacturing activity.

Financial developments

Long-term yields have declined in the euro area and in the United States. During the period under review (from 13 December 2018 to 23 January 2019), the GDP-weighted euro area ten-year sovereign bond yield fell to 0.98% (down 9 basis points) as global risk-free rates decreased and intra-period financial market volatility increased (see Chart 3). In the United States, the ten-year sovereign bond yield fell by 16 basis points to 2.74%, while in the United Kingdom the ten-year sovereign bond yield rose by 2 basis points to 1.33%.

Euro area sovereign bond spreads relative to the risk-free OIS rate are broadly unchanged. Spreads for Spanish and Portuguese sovereign bonds were broadly unchanged during the review period, at 72 basis points and 100 basis points respectively. Italian spreads decreased by 8 basis points but remained at elevated levels around 2.17%. German spreads increased by 6 basis points to -0.37% and French spreads increased by 1 basis point to 0.04%.

Broad indices of euro area equity prices are, overall, broadly unchanged despite heightened market volatility around the turn of the year. Over the review period, equity prices of euro area banks and non-financial corporations increased by around 1%. Elevated levels of global uncertainty, coupled with negative macroeconomic surprises, led to a broad-based sell-off across jurisdictions and a heightened level of volatility, exacerbated by temporarily low liquidity around the turn of the year. Thereafter, equity markets partly recovered from earlier losses and volatility became more muted.

Euro area corporate bond spreads widened somewhat over the review period. Since December the spread on investment-grade NFC bonds relative to the risk-free rate has increased by around 2 basis points to stand at 95 basis points. Yields on financial sector debt have also increased slightly, resulting in a widening of the spread of around 2 basis points to 120 basis points. Overall, despite a gradual increase in 2018, corporate bond spreads still remain below the levels observed in March 2016, prior to the announcement and subsequent launch of the corporate sector purchase programme.

The euro overnight index average (EONIA) was, on average, -36 basis points over the review period. Excess liquidity declined by around €43 billion to around €1,847 billion. This decline was mainly driven by an increase in net autonomous factors and, to a lesser extent, early repayments in the second series of targeted longer-term refinancing operations (TLTRO-II).

The EONIA forward curve shifted downwards somewhat over the review period. The curve remains below zero for horizons prior to 2021, reflecting market expectations of a prolonged period of negative interest rates.

In foreign exchange markets, the euro has depreciated in trade-weighted terms (see Chart 4). Over the review period the nominal effective exchange rate of the euro, measured against the currencies of 38 of the euro area’s most important trading partners, depreciated by 1.0%. This resulted from a broad-based depreciation of the euro against most major currencies. In particular, the euro depreciated against the Japanese yen (by 3.4%) and the British pound (by 2.9%), while it was broadly unchanged against the US dollar. The euro also weakened against the Chinese renminbi (by 1.4%) and the currencies of other major emerging economies, including the Turkish lira, the Brazilian real and the Russian rouble, which continued to recover some of their previous losses.

Economic activity

Incoming information has surprised on the downside. Real GDP increased by 0.2%, quarter on quarter, in the third quarter of 2018, following growth of 0.4% in the two previous quarters (see Chart 5). Domestic demand and changes in inventories made positive contributions to the third quarter outcome, whereas net trade contributed negatively to GDP growth. Economic indicators point to ongoing but continued moderate growth in the final quarter of last year.

Employment continued to increase in the third quarter of the year, rising by 0.2%, quarter on quarter (see Chart 6). The level of employment currently stands 2.6% above the pre-crisis peak recorded in the first quarter of 2008. Employment increased in most euro area countries and the increase was also broadly based across sectors. With the latest increase, cumulative employment growth in the euro area since the trough in the second quarter of 2013 amounts to 9.6 million persons. Continuing employment growth in combination with the decline in GDP growth in 2018 has translated into a moderation in productivity growth, following a modest pick-up in 2017.

Looking ahead, short-term indicators point to continued positive employment growth in the coming quarters, although it is likely to be slower than before. The euro area headline unemployment rate declined to 7.9% in November – the lowest level seen since October 2008 – after being flat for three months (see Chart 6). Survey indicators weakened in the last quarter of 2018, and point to weaker employment growth in the coming quarters, though still in a positive range.

Rising employment continued to support household income and consumer spending. Private consumption rose by 0.1%, quarter on quarter, in the third quarter of 2018, following a similar rate of expansion in the previous quarter. Temporary bottlenecks in car production following the introduction of the new Worldwide Harmonised Light Vehicle Test Procedure (WLTP) had an adverse impact on economic activity and, in particular, the consumption of durable goods. Growth of consumption of non-durable goods, i.e. food and energy, also slowed down. As this component of consumer spending has arguably been more sensitive to past increases in oil prices, and oil prices weakened in the fourth quarter, its weakness is also to some extent of a more temporary nature. By contrast, in line with strong growth in the real compensation of employees, consumption of services, the largest component of consumer spending, remained robust.

Despite the recent deceleration in growth, private consumption is expected to regain momentum going forward. Recent data on the volume of retail sales and new passenger car registrations point to slow but steady growth in consumer spending in the fourth quarter of 2018. Other indicators, however, support the picture of more resilient consumption dynamics. The latest survey results signal further labour market improvements, which should continue to support household income and consumer spending. Moreover, households’ net worth continued to increase at robust rates in the third quarter. Although consumer confidence has been on a broadly declining trend since the end of 2017, it still stands above its long-term average.

Following a strong second quarter in 2018, investment growth slowed in the third quarter. Following a rate of 1.8%, quarter on quarter in the second quarter, non-construction investment grew by 1.2% in the third quarter, driven by machinery and equipment, intellectual property products (IPP) and transport equipment. The decline in growth would have been stronger had it not been for a special effect associated with R&D and IPP investment in Ireland. Quarterly growth in construction investment moderated to 0.2%, supported by dynamic residential investment growth at 0.7%. For the fourth quarter of 2018, short-term indicators point to continued growth. In October and November monthly data on capital goods production stood on average at the same level as in the third quarter, when growth was 0.9% on a quarterly basis, which points to a further slowdown in non-construction growth. Indicators such as capacity utilisation, confidence and new orders are also consistent with slower growth in the fourth quarter. With regard to construction investment, construction production contracted in October and November, while PMI and confidence indices for the construction sector up to December still pointed to continued – but moderating – growth in the fourth quarter of 2018.

Investment is expected to continue to grow, though at a slowing pace. The slightly declining path expected for non-construction investment growth will be driven by weakening domestic and foreign demand as well as decreasingly favourable financial conditions. Also profits, which are firms’ main source of funding for investment, seem to be growing at a declining rate. According to the euro area sectoral accounts for the third quarter of 2018, non-financial corporations’ gross operating surplus slowed strongly in year-on-year terms. Moreover, uncertainties surrounding Brexit, trade protectionism and the general outlook for global growth, inter alia, may already be proving unfavourable to investment decisions. As regards construction investment, households’ increasing intentions to buy or renovate, constructors’ buoyant price and employment expectations, and stable issuance of building permits, amid persistent limits from labour shortages and insufficient demand, point to a positive – but softening – momentum in the construction sector going forward.

After disappointing in the third quarter, growth in euro area foreign trade appears set to decline further in the fourth quarter of 2018. The pace of euro area export growth slowed down substantially (to 0.1%) in the third quarter, whereas growth in imports eased (to 1.0%). As a result net trade exerted a drag on economic activity with a large negative contribution to GDP growth (of 0.4 percentage point). Based on information up to November, euro area foreign trade is assessed as having further weakened in the fourth quarter, reflecting a moderation in growth in intra-euro area trade amid weak foreign demand. The expansion of export volumes of goods (obtained by deflating trade values by producer price indices) remained very moderate (at 0.8%, quarter on quarter), while import growth is likely to have undergone a correction (to -0.8%) in the fourth quarter. Survey indicators with leading properties for trade, such as the Purchasing Managers’ Index (PMI) for new manufacturing export orders and the European Commission’s assessment of export order book levels, also anticipate a gloomier outlook towards the end of the year.

Incoming data have been weaker than expected, reflecting a diminishing contribution from external demand and some country and sector-specific factors. While some of these factors are likely to unwind, this may suggest some slower growth momentum ahead. Following growth of close to zero in October, industrial production (excluding construction) declined by 1.7%, month on month, in November. As a result, on average over these two months production stood 0.7% below the level seen in the third quarter of 2018, when it declined by 0.1% on a quarterly basis. The weak November outcome was broadly based across the main industrial groupings as well as the largest euro area countries. More timely survey data signal continued moderate growth, but at rates lower than those seen during the first half of last year. The composite output PMI averaged 52.3 in the fourth quarter of 2018, compared with 54.3 in the third quarter, while the European Commission’s Economic Sentiment Indicator (ESI) eased to 108.8 from 111.5 between the same quarters (see Chart 5). While the ESI has continued to stand above its long-term average, the PMI is now below its historical average.

Looking ahead, the euro area expansion will continue to be supported by favourable financing conditions. In addition, growth should also be underpinned by further employment gains and rising wages, lower energy prices, and the ongoing – albeit somewhat slower – expansion in global activity. Box 2 elaborates further on factors that are expected to either underpin or adversely affect domestic activity going forward. The results of the latest round of the ECB Survey of Professional Forecasters, conducted in early January, show that the GDP growth forecasts made by the private sector were revised downwards for 2019 and 2020 compared with the previous round, conducted in early October.

The risks surrounding the euro area growth outlook have moved to the downside. The more negative risk assessment reflects the persistence of uncertainties related to geopolitical factors and the threat of protectionism, vulnerabilities in emerging markets, and financial market volatility.

Prices and costs

Euro area annual HICP inflation was 1.6% in December 2018, down from 1.9% in November (see Chart 7). This decrease mainly reflected lower energy price inflation and also, to a lesser extent, lower food price inflation. The decline in headline inflation since its peak in October 2018 was largely due to energy inflation, which was pushed down by a base effect and the impact of recent declines in oil prices. The decline in oil prices and the corresponding futures prices after mid-November was more substantial than had been expected in the December 2018 Eurosystem staff projections. This mechanically implies a weaker short-run outlook for headline inflation (see the box entitled “The mechanical impact of changes in oil price assumptions on projections for euro area HICP energy inflation” in this issue of the Economic Bulletin).

Measures of underlying inflation have been moving sideways recently but stand above earlier lows. HICP inflation excluding energy and food was 1.0% in December, unchanged from November. The same holds for HICP inflation excluding energy, food and highly volatile components, such as travel-related items, clothing and footwear. In recent months broadly sideways developments were also evident in two model-based measures of underlying inflation, the Persistent and Common Component of Inflation indicator and the Supercore indicator. Nonetheless, each of the statistical and model-based measures remained higher than their respective lows in 2016.

Supply chain price pressures for HICP non-energy industrial goods remained resilient despite further weakness in the early stages of the chain. Price pressures in the early stages continued to weaken; the annual rate of change of oil prices in euro was -4.9% in December, down from 9.7% in November and 43.8% in October, and the annual rate of change of raw material prices was 0.4% in December, down from 4.8% and 6.2% the previous two months. In the later stages of the supply chain, import price inflation for non-food consumer goods continued to strengthen in November, and so remained substantially higher than its lows in early 2018. Domestic producer price inflation for non-food consumer goods increased further to 0.9% in November, its highest rate since April 2012, and above its long-term average of 0.6%. Overall, price pressures in the later stages of the supply chain for industrial goods remained steady, albeit with a risk of the continued weakness in the early stages filtering through.

Rising labour cost pressures did not translate into further increases in overall domestic price pressures recently as they were buffered by profit margins. Price pressures from labour costs continued to intensify in the third quarter of 2018 due to higher growth in compensation per employee as well as weaker growth in productivity. Still, the annual percentage change in the GDP deflator remained stable at 1.4% in the first three quarters of 2018, as the overall weakening in the cyclical momentum of the economy, together with deteriorations in the terms of trade (related particularly to the past increases in oil prices), weighed on profit margin developments. These latest developments in the GDP deflator and its decomposition are characteristic of a more mature phase of a demand-driven recovery^[1].

Both market-based and survey-based measures of longer-term inflation expectations declined. The five-year forward inflation-linked swap rate five years ahead stood at 1.54% on 23 January 2019, around 9 basis points lower than the level that prevailed in mid-December. The forward profile of market-based measures of inflation expectations continues to point towards a prolonged period of low inflation with a very gradual return to inflation levels below, but close to, 2% (see Chart 8). The risk-neutral probability of negative average inflation over the next five years implied by inflation options markets remains negligible, which suggests that markets currently consider the risk of deflation to be very low. The results of the ECB Survey of Professional Forecasters (SPF) for the first quarter of 2019 show average headline inflation expectations for the euro area of 1.5% in 2019, 1.6% in 2020 and 1.7% in 2021. This represents downward revisions of 0.2 and 0.1 percentage point to 2019 and 2020, respectively, compared with the previous survey, mainly attributable to oil price developments. According to the SPF, average longer-term inflation expectations were 1.8%, a downward revision of 0.1 percentage point.

Residential property prices in the euro area continued to rise in the third quarter of 2018. According to the ECB’s residential property price indicator, prices for houses and flats in the euro area increased by 4.3% year on year in the third quarter of 2018, compared with 4.2% and 4.3% in the second and first quarters of 2018 respectively. The data for the first three quarters of 2018 thus imply a sideways movement at robust rates of growth.

Money and credit

Broad money growth moderated in November. The annual growth rate of M3 decreased to 3.7% in November from 3.9% in October (see Chart 9). The reduction in net asset purchases (from €80 billion to €60 billion in April 2017, to €30 billion in January 2018, and then to €15 billion in October 2018) has led to a smaller positive impact of the APP on M3 growth. The annual growth rate of M1, which again made a significant contribution to broad money growth, decreased to 6.7% in November (down from 6.8% in October). Money growth continued to be bolstered by sustained economic expansion and the low opportunity cost of holding the most liquid instruments in an environment of very low interest rates.

Credit to the private sector remained the largest driver of broad money growth. From a counterpart perspective, the positive contribution to M3 growth from general government securities held by the Eurosystem decreased further (see the red bars in Chart 9) in the context of the aforementioned reduction in monthly net purchases under the APP. It has been largely offset by a moderate increase in the contribution from credit to the private sector since late 2017 (see the blue bars in Chart 9). This marks an ongoing shift towards more self-sustained sources of money creation, with credit to the private sector surpassing Eurosystem purchases of general government debt securities as the largest contributor to M3 growth since October 2018. By contrast, government bond sales by euro area monetary financial institutions (MFIs) excluding the Eurosystem dampened M3 growth (see the light green bars in Chart 9). Finally, the contribution from net external assets (see the yellow bars in Chart 9) was again positive in November.

The annual growth of loans to the private sector remained stable in November. The annual growth rate of MFI loans to the private sector (adjusted for loan sales, securitisation and notional cash pooling) was unchanged in November at 3.3% (see Chart 10). It benefited from increases in the annual growth rate of loans to NFCs, which increased from 3.9% in October to 4.0% in November, and of loans to households, which increased from 3.2% in October to 3.3% in November. These slight increases in loans to NFCs and households were offset by a decrease in the annual growth rate of loans to financial intermediaries, leading to no change in the growth rate of loans to the private sector overall. While the annual growth rate of loans to households for house purchase remained moderate from a historical perspective, loan origination was strong. The recovery in loan growth has been supported by the significant decline in bank lending rates across the euro area since mid-2014 (notably owing to the ECB’s non-standard monetary policy measures) and by overall improvements in the supply of, and demand for, bank loans. In addition, banks have made progress in consolidating their balance sheets, although the volume of non-performing loans (NPLs) remains high in some countries and may constrain financial intermediation.^[2]

Loan growth continued to be supported by favourable bank lending conditions and increasing loan demand across all loan categories. According to the January 2019 euro area bank lending survey, credit standards for loans to enterprises and loans to households for house purchase remained broadly unchanged in the fourth quarter of 2018. These developments follow a considerable overall net easing of credit standards since 2014. Competitive pressures continued to contribute to an easing of credit standards for loans to enterprises and housing loans, while lower risk perceptions only contributed to an easing of credit standards for housing loans. Increasing net loan demand is largely due to the low general level of interest rates, fixed investment, inventories and working capital, merger and acquisition activity, favourable housing market prospects and consumer confidence. Euro area banks also reported that regulatory or supervisory actions led to a further strengthening of their capital positions in the second half of 2018 and a tightening of their credit standards across all loan categories. With regard to the impact of NPL ratios on lending policies, euro area banks reported that these ratios had a tightening impact on their credit standards for loans to enterprises and housing loans over the past six months, which is expected to persist and to affect all loan categories.

Very favourable lending rates continued to support euro area economic growth. In November 2018 the composite bank lending rate for loans to NFCs remained broadly stable at 1.66%, which is close to its historical low in May 2018. The composite bank lending rate for housing loans remained stable in November at 1.81%, also close to its historical low in December 2016 (see Chart 11). Composite bank lending rates for loans to NFCs and households have fallen significantly and by more than market reference rates since the ECB’s credit easing measures were announced in June 2014. The reduction in bank lending rates 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 most exposed to the financial crisis. This indicates a more uniform transmission of monetary policy to bank lending rates across euro area countries and firm sizes.

Net issuance of debt securities by euro area NFCs decreased slightly in the first two months of the fourth quarter of 2018 after increasing moderately in the same months of the previous quarter. The latest ECB data indicate that, on a net basis, the total flow of debt securities issued by NFCs in October and November 2018 was marginally negative. This contrasts with the typical seasonal patterns observed over the last few years, in which weakness in issuance has tended to be concentrated in the last month of the fourth quarter. From a more medium-term perspective (see Chart 12), the annual flows of debt securities continued to decrease. They reached €44 billion in November 2018, following a drop of €30 billion over the previous 12 months. Available market data suggest that net debt securities issuance remained weak in December 2018 but eventually recovered somewhat at the beginning of January 2019. In October and November 2018, total net issuance of quoted shares by NFCs was quite robust, improving from the slightly negative figure recorded in the first two months of the third quarter of 2018. In terms of annual flows, net issuance of quoted shares remained close to the highest levels recorded since 2012.

Despite edging up in recent months, financing costs for euro area NFCs remained favourable overall. The overall nominal cost of external financing for NFCs, comprising bank lending, debt issuance in the market and equity finance, remained at around 4.7% in November and is projected to have increased further in December 2018 and January 2019. Although the cost of financing is currently estimated to be around 54 basis points above the historical low of August 2016, it is still below the levels observed in the summer of 2014. The increase in the cost of financing since the end of the third quarter of 2018 reflects an increase in both the cost of equity and in the cost of market-based debt. The cost of both short and long-term bank lending remained relatively stable over the same period.

Boxes

Recent developments in oil prices

Prepared by Dominic Quint

Against the background of large swings in oil prices in recent months, this box assesses the key drivers of oil market developments. While demand has been relatively stable, supply factors have been the main driving force behind recent oil price volatility.

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Driving factors of and risks to domestic demand in the euro area

Prepared by Malin Andersson and Benjamin Mosk

Activity in the euro area is expected to continue to expand at a moderate pace, while more elevated uncertainty points to intensified downside risks to the growth outlook. Heightened uncertainties at the global level, the prospect of Brexit, escalating protectionism, volatility in emerging market economies (EMEs) and policy uncertainty in some parts of the euro area pose major challenges to the sustainability of domestic demand going forward. According to the December 2018 Eurosystem staff macroeconomic projections,^[3] the growth outlook is expected to be underpinned by sustained growth in domestic demand over the next few years, notwithstanding a very limited contribution from net exports and inventories (see Chart A). Even though growth is expected to slow, which is consistent with a maturing business cycle in which labour supply shortages increase in some countries and saving ratios recover from their low levels, activity is expected to be relatively resilient owing to a number of factors, including the expected continued expansion of global activity, the accommodative monetary policy stance supporting financing conditions, improving labour markets, rising wages and some fiscal loosening. This box reviews the factors underpinning domestic expenditure and assesses the potential adverse effects on domestic activity of heightened global uncertainty.

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The mechanical impact of changes in oil price assumptions on projections for euro area HICP energy inflation

Prepared by Mario Porqueddu

Inflation projections are based on models, assumptions and expert judgement. These include assumptions regarding the future evolution of oil prices. In the case of the Eurosystem/ECB projection exercises, the inflation projections are based on the assumption that oil prices will evolve in line with the average futures prices observed over a two-week period prior to the projection cut-off date. Using the oil price futures has an important bearing on the projections for HICP energy inflation. For instance, the pattern of HICP inflation in the December 2018 Eurosystem staff projections entailed, among other things, a strong decline in the contribution of energy inflation, from 0.6 percentage point in 2018 to 0.2 percentage point in 2019 and 0.1 percentage point in 2020 and 2021 (see Chart A).^[4] However, the cut-off date for the assumptions underlying these projections was 21 November 2018, and oil prices and their corresponding futures paths fell significantly after this date. While they have recovered somewhat lately compared with the end of 2018, they remain on balance substantially below the levels on the cut-off date. This box documents the mechanical implications of a shift in the oil price assumptions for the projections of the energy component of HICP inflation.

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Articles

Twenty years of the ECB Survey of Professional Forecasters

Prepared by Rupert de Vincent‑Humphreys, Ivelina Dimitrova, Elisabeth Falck and Lukas Henkel

It is twenty years since the ECB first launched its Survey of Professional Forecasters (SPF). The survey asks for point forecasts and probability distributions for HICP inflation, HICP inflation excluding energy, food, alcohol and tobacco, real GDP growth and the unemployment rate at six horizons, as well as point forecasts for wage growth, the exchange rate, the oil price and the ECB’s policy rate. All quantitative data collected in the survey are systematically published shortly after the completion of the survey. This makes the SPF the most long-standing, comprehensive and transparent survey of the aggregate euro area economy.

The past twenty years have seen a wide variety of economic conditions, including the Great Moderation, with relatively high economic growth and stable inflation, the financial crisis and, more recently, a prolonged period of subdued inflationary pressures. This article documents the evolution of the SPF through this changing economic landscape and what we have learned from it. The SPF remains as useful for economic analysis and as relevant to the monetary policy debate today as it was when it was first launched.

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Fiscal spillovers in a monetary union

Prepared by Mario Alloza, Bogdan Cozmanca, Marien Ferdinandusse and Pascal Jacquinot

The article describes the main transmission channels of the spillovers of national fiscal policies to other countries within a monetary union and investigates their magnitude using different models. In the context of Economic and Monetary Union (EMU), fiscal spillovers are relevant for the accurate assessment of the cyclical outlook in euro area countries, as well as in the debates on a coordinated change in the euro area fiscal stance and on euro area fiscal capacity. The article focuses on spillovers from expenditure-based expansions in the larger euro area countries by presenting two complementary exercises. The first is an empirical investigation of spillovers based on a new, long dataset for the largest euro area countries, while the second uses a multi-country general equilibrium model with a rich fiscal specification and the capacity to analyse trade spillovers. Fiscal spillovers are found to be heterogeneous but generally positive among the larger euro area countries. The reaction of interest rates to fiscal expansion is an important determinant for the magnitude of spillovers.

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Statistics

Statistical annex