Economic Bulletin Issue 1, 2024

= Update on economic, financial and monetary developments =

Summary

• At its meeting on 25 January 2024, the Governing Council decided to keep the three key ECB interest rates unchanged.
• The incoming information broadly confirmed its previous assessment of the medium-term inflation outlook.
• The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner.

Economic activity

• However, some forward-looking survey indicators point to a pick-up in growth further ahead.
• Following the recent ECOFIN Council agreement on the reform of the EU’s economic governance framework, the legislative process should be concluded swiftly so that the new rules can be implemented without delay.
• Moreover, it is imperative that progress towards capital markets union and the completion of banking union be accelerated.

Inflation

• Inflation rose to 2.9% in December 2023 as some of the past fiscal measures to cushion the impact of high energy prices dropped out of the annual inflation rate, although the rebound was weaker than expected.
• [2] Aside from this base effect, the overall trend of declining inflation continued.
• Inflation excluding energy and food also declined again, to 3.4%, due to a fall in goods inflation to 2.5%.
• Measures of shorter-term inflation expectations have come down markedly, while those of longer-term inflation expectations mostly stand around 2%.

Risk assessment

• Growth could be lower if the effects of monetary policy turn out stronger than expected.
• A weaker world economy or a further slowdown in global trade would also weigh on euro area growth.
• Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East are key sources of geopolitical risk.

Financial and monetary conditions

• Market interest rates have moved broadly sideways since the Governing Council’s monetary policy meeting on 14 December 2023.
• The Governing Council’s restrictive monetary policy continues to transmit strongly into broader financing conditions.
• Lending rates on business loans declined slightly, to 5.2% in November, while mortgage rates increased further to 4.0%.

Monetary policy decisions

• The asset purchase programme portfolio is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.
• The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.
• As banks are repaying the amounts borrowed under the targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted lending operations and their ongoing repayment are contributing to its monetary policy stance.

Conclusion

• At its meeting on 25 January 2024, the Governing Council decided to keep the three key ECB interest rates unchanged.
• The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner.

1 External environment

• Core inflation continued to decline in the fourth quarter, but further progress might be sluggish as wage growth is still high, remaining above long-term averages.
• High frequency indicators, such as global retail sales, also suggest a slowdown in consumer spending towards the end of the year.
• Merchandise trade growth momentum returned to positive territory in October 2023, amid broad-based improvements across countries globally.
• This is due to the comparatively lower growth in demand for goods, higher spare shipping capacity and reduced congestion in ports currently being observed.

Chart 1

• The global charter rate (HARPEX) is the HARPER PETERSEN Charter Rates Index, which tracks the cost of chartering container vessels operating on all routes globally.
• Annual headline consumer price index (CPI) inflation across OECD member countries excluding Türkiye decreased to 3.4% in November, down from 3.6% in October, owing to some easing in food price inflation (Chart 2).
• Core inflation (headline inflation excluding food and energy) also declined in November, falling 0.2 percentage points to 4.1%, but remains elevated.

Chart 2

• Core inflation refers to headline inflation excluding food and energy.
• Developments in energy commodity prices have been mixed since the Governing Council’s meeting in December 2023, amid higher oil prices and lower gas prices.
• Oil prices in US dollars have risen by 10.4% amid concerns that attacks on ships in the Red Sea could affect shipments of oil through the Suez Canal, which serves as a key passage for global oil traded by sea (Chart 3).

Chart 3

• The latest observations are for 24 January 2024 for oil and gas, and 19 January 2024 for commodities excluding energy.
• Non-energy commodity prices have been stable amid slightly higher metal prices, but lower food prices.
• Since the December meeting of the Governing Council, metal prices have increased by 1%, driven mainly by higher prices for tin, lead and aluminium.
• Food commodity prices have declined by 1.7% on the back of falling soybean and grain prices.
• [3] High frequency indicators, such as credit card spending, suggest a deceleration in consumer spending at the turn of the year.
• At the same time, rising consumer loan delinquencies indicate that household balance sheets are coming under increasing pressure.
• However, a recent fall in mortgage rates has stimulated new mortgage borrowing and could boost consumer spending to some extent.

2 Economic activity

• [4] * This comes on the back of the prolonged weakness in global trade and of strong monetary policy transmission.
• Incoming data show signs of a modest strengthening of growth in the first quarter of 2024.
• The labour market remains resilient, although more recent indicators suggest signs of cooling following the protracted period of weak economic activity.
• The euro area economy is expected to start gradually improving over the course of this year.
• Growth is expected to be supported by rising real disposable income, which in turn should benefit from declining inflation and robust wage growth.

Chart 4

• The European Commission’s Economic Sentiment Indicator (ESI) has been standardised and rescaled to have the same mean and standard deviation as the composite output PMI.
• Although euro area output growth remains weak, it is expected to show some improvement at the beginning of 2024.
• However, the composite output PMI improved slightly, further reflecting a robust increase in manufacturing output, alongside a small decline in services sector business activity (Chart 5).

Chart 5

• The labour market remains resilient, albeit recent indicators signal a cooling following weaker economic activity.
• Employment growth continued to be robust in the third quarter of the year, at a quarterly rate of 0.2%.
• As the labour force continued to grow, the unemployment rate returned to its lowest level since the beginning of the euro, standing at 6.4% in November, down from 6.5% in October 2023 (Chart 6).
• The improvement compared with December 2023 notwithstanding, the PMI composite employment indicator has, overall, followed a downward trend since April 2023.

Chart 6

• The PMI is expressed in terms of the deviation from 50 divided by 10.
• The latest observations are for the third quarter of 2023 for employment, January 2024 for the PMI assessment of employment and November 2023 for the unemployment rate.
• Private consumption growth remained weak in the last quarter of 2023, reflecting continued subdued spending on goods.
• By contrast, there was no strong downward correction in expected demand for contact-intensive services, which continued to hold up in December, remaining above its historical average (Chart 7).

Chart 7

• Notes: “Contact-intensive services” refers to the weighted average of accommodation, food and travel services.
• The latest observations are for December 2023.
  Business investment growth is likely to have slowed in the fourth quarter amid weak demand and tight financing conditions.
• At the same time, while PMI new orders remained in contractionary territory in the fourth quarter of 2023, the existing stock of orders still assured capital goods production for a longer period than they did in pre-pandemic times, according to the European Commission’s business and consumer survey (Chart 8, panel a).

Chart 8

• Business investment and PMI new orders for capital goods are expressed as deviations from the 1999-2019 average.
• Months of assured capital goods production out of existing orders are expressed as deviations from the 1999-2019 average.
• The index for building construction production is computed as the percentage change over the average level in the previous quarter.
• Housing investment is likely to have fallen further in the fourth quarter of 2023, as shown by hard and soft indicators.
• Looking ahead, as global activity recovers and the inventory drawdown diminishes, the drag on euro area exports should gradually fade.

3 Prices and costs

• [5] * Inflation excluding energy and food declined again, from 3.6% in November to 3.4% in December, driven by the decline in goods inflation.
• Measures of longer-term inflation expectations stand at around 2%, while measures of shorter-term expectations have come down markedly.
• The increase was driven by a less negative energy inflation rate, mainly due to base effects.
• Meanwhile food inflation and HICP inflation excluding energy and food declined further.

Chart 9

• As expected, energy inflation saw an increase in December, but the change to -6.7% from -11.5% in November was smaller than anticipated.
• The main driver of the less negative annual rate of change was a large base effect.
• This was related to both the one-off gas support measures in Germany and a substantial drop in fuel prices in December 2022.
• Food inflation continued to decline, to 6.1% in December from 6.9% in November, but remained elevated (Chart 10).
• This reflected declines in energy costs and food commodity prices as measured by, for instance, euro area farm gate prices.

Chart 10

• Note: The latest observations are for November 2023 for the producer price indices and December 2023 for euro area farm gate prices and HICP food inflation.
• Producer and import price pressures continued to remain negative across all main industrial categories (Chart 11).
• At the early stages of the pricing chain, producer price inflation for domestic sales of intermediate goods was negative and unchanged (-5.3% in November and October).
• The same unwinding tendencies hold for producer prices and import prices in the manufactured consumer goods segment, confirming the general gradual easing of pipeline pressures on consumer goods prices.

Chart 11

• Measures of underlying inflation in the euro area continued to decrease, as the impact from past shocks fades and demand eases amid tighter monetary policy (Chart 12).
• The Persistent and Common Component of Inflation (PCCI) remained at the bottom of the range, declining further to 1.9% in December.
• The Supercore indicator, which includes cyclically sensitive HICP items, continued its decline from 4.4% in November to 4.0% in December, but remains relatively high.
• Domestic inflation (comprising items with a low import content) is also moderating from more elevated levels than other measures.

Chart 12

• The grey dashed line represents the ECB’s inflation target of 2% over the medium term.
• Wage growth measures had been moving broadly sideways recently, at elevated levels.
• The forward-looking wage trackers signal continued high wage pressures, although with some tentative signs of a cooling down by the end of 2023.
• Most survey-based indicators of longer-term inflation expectations in the euro area, as well as market-based measures of inflation compensation adjusted for risk premia, are at around 2% (Chart 13).
• [6] With regard to perceptions of past inflation, they did not follow the decline in HICP inflation between June and October 2023.
• However, they eased considerably from October 2023 onwards, with the median declining from 8.0% in September to 6.2% in December.

Chart 13

• Notes: The market-based measures of inflation compensation series are based on the one-year spot inflation rate, the one-year forward rate one year ahead, the one-year forward rate two years ahead and the one-year forward rate three years ahead.
• The observations for market-based measures of inflation compensation are for 24 January 2024.
• Inflation fixings are swap contracts linked to specific monthly releases in euro area year-on-year HICP inflation ex.

4 Financial market developments

• Over the review period (14 December 2023 to 24 January 2024), developments in the euro area financial markets reflected evolving policy rate expectations as markets continued to focus on the pace of disinflation and the expected monetary policy adjustments.
• By contrast, policy rate expectations over longer horizons fluctuated more markedly, but ended the review period close to their mid-December levels.
• * *Equity prices remained range bound as declines in earnings expectations were offset by a reduction in the equity risk premium.
• Euro area corporate bond markets were broadly unchanged, with some decline in the high-yield segment.
• Euro area near-term risk-free rates ended the review period broadly in line with the levels prevailing around the time of the December Governing Council meeting.

Chart 14

• Notes: The vertical grey lines denote the start of the review period on 14 December 2023.
• Corporate bond spreads were largely unchanged over the review period, with spreads in the high-yield segment narrowing.
• The spreads for investment-grade firms ended the review period broadly unchanged, while spreads in the high-yield segment were more volatile, narrowing by 34 basis points.
• Euro area equity prices remained range bound as declines in earnings expectations were offset by a reduction in the equity risk premium.
• In foreign exchange markets, the euro appreciated slightly in trade-weighted terms (Chart 15).

Chart 15

• Changes in the exchange rate of the euro vis-à-vis selected currencies
  (percentage changes)

  Source: ECB calculations.

• Notes: EER-41 is the nominal effective exchange rate of the euro against the currencies of 41 of the euro area’s most important trading partners.

5 Financing conditions and credit developments

• Demand for loans by firms and households continued to decrease substantially, albeit less steeply than in the previous quarter.
• In the second half of 2023, bank lending conditions for firms tightened more in the real estate and construction sectors than in others.
• The weakness in bank lending to firms and households continued in November, reflecting the strong pass-through of policy tightening to lending rates, combined with lower loan demand and tighter credit standards.
• Money growth continued to contract, with annual rates close to historical lows, owing to high opportunity costs, subdued credit growth and the reduction in the Eurosystem balance sheet.

Chart 16

• Notes: Composite bank funding costs are a weighted average of the composite cost of deposits and unsecured market-based debt financing.
• The latest observations are for November 2023 for banks’ composite cost of debt financing and for 24 January 2024 for bank bond yields.
• In November 2023 lending rates for firms declined slightly for the first time since July 2022, while the rates for housing loans increased further.
• This led to a sharp increase in lending rates for both firms and households across euro area countries (Chart 17).
• The cross-country dispersion of lending rates for firms and households remained at a low level (Chart 17), suggesting smooth monetary policy transmission across euro area countries.

Chart 17

• Notes: Composite bank lending rates for non-financial corporations (NFCs) are 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 composite cost of bank borrowing, market-based debt and equity – declined significantly from the multi-year high reached in October and stood at 6.07%, which is almost 50 basis points lower than in the previous month (Chart 18).

Chart 18

• According to the January 2024 euro area bank lending survey , credit standards for loans to firms tightened moderately further in the fourth quarter of 2023 (Chart 19).
• The impact of past tightening will continue to dampen loan growth in the coming quarters.
• Euro area banks expect the tightening of credit standards for loans to firms to pick up in the first quarter of 2024.

Chart 19

• Banks reported a further net tightening of credit standards for loans to households in the fourth quarter of 2023, which was small for housing loans and more pronounced for consumer credit.
• For both loan categories, the net tightening was lower than in the third quarter, in line with banks’ expectations.
• Banks also reported a further net increase in the share of rejected loan applications for loans to firms and for housing loans.
• Reflecting a large monthly flow, annual growth in loans to NFCs rebounded slightly to stand at 0.0% in November, up from ‑0.3% in October (Chart 20, panel a), amid considerable heterogeneity across countries and maturities.
• The annual growth rate of loans to households edged down to 0.5% in November, after 0.6% in October (Chart 20, panel b), amid negative housing market prospects, somewhat tighter credit standards and higher lending rates.
• unincorporated small businesses), while consumer loans remained more resilient, despite a further tightening of credit standards and low consumer confidence.

Chart 20

• The cross-country standard deviation is calculated using a fixed sample of 12 euro area countries.
• Households continued to reallocate overnight deposits to time deposits in November, while firms moderated these shifts as their deposit allocation normalised.
• The annual growth rate of overnight deposits continued its double-digit decline to stand at ‑10.9% in November, up from ‑11.5% in October (Chart 21).

Chart 21

• In November 2023 money growth continued to contract at annual rates close to recent historical lows driven by high opportunity costs, subdued credit growth and the reduction in the Eurosystem balance sheet.
• Annual broad money (M3) growth in the euro area stabilised around historically low rates, standing at ‑0.9% in November, up from ‑1.0% in October and ‑1.2% in September (Chart 21).
• Annual narrow money (M1) growth continued to decline at a close to double-digit rate, with weak monetary dynamics being reinforced by portfolio shifts.
• At the same time, a growing current account surplus amid weak imports has led to higher monetary inflows from the rest of the world.

1 Global trade in the post-pandemic environment

• When global activity collapsed at the start of the pandemic, triggering the deepest global recession (albeit short-lived) since the Second World War amid large-scale policy support, there was also a sweeping fall in world trade.
• In the first two quarters of 2020, global trade contracted by 16%, exceeding even the shock observed during the global financial crisis.
• According to the December 2023 Eurosystem staff macroeconomic projections, global trade may have grown by just 1.1% in 2023, well below its average annual growth over the pre-pandemic period (2012 to 2019) and subpar compared with global GDP growth in 2023 (Chart A, panel b).

2 Is the PMI a reliable indicator for nowcasting euro area real GDP?

• More
  The euro area composite output Purchasing Managers' Index (PMI) tends to be strongly correlated with real GDP growth (Chart A).
• The PMI survey output question asks about the actual unit volume of output this month compared to the previous month.
• Moreover, the euro area composite output is based solely on the four largest euro area countries and Ireland.

3 Main findings from the ECB’s recent contacts with non-financial companies

• This box summarises the findings of recent contacts between ECB staff and representatives of 70 leading non-financial companies operating in the euro area.
• There was still a lot of variation both within and across sectors in terms of reported dynamics.
• Consequently, developments in manufacturing activity were now considered to better reflect the evolution of final consumption and investment demand.

4 Assessing the macroeconomic effects of climate change transition policies

• More
  This box gauges the macroeconomic impact of climate change policies aimed at reducing greenhouse gas emissions.
• The box therefore goes on to illustrate the medium-term impact of alternative transition policy scenarios using model simulations.

5 Corporate vulnerabilities as reported by firms in the SAFE

• More
  This box analyses corporate vulnerabilities as derived from firm-level replies to the *Survey on the Access to Finance of Enterprises (SAFE) [13] The concept is particularly relevant when assessing the implications for the transmission of monetary policy as it provides strong signals on the financial health of firms.
• *.A firm is considered vulnerable if it simultaneously reports lower turnover, lower profits, higher interest expenses and a higher or unchanged debt-to-assets ratio over the past six months.

6 Policy expectation errors during the recent tightening cycle – insights from the ECB’s Survey of Monetary Analysts

• More
  Information from the Survey of Monetary Analysts * (SMA) on respondents’ expectations about the future evolution of the ECB’s monetary policy measures can provide insights into the source of expectation errors during the recent tightening cycle.
• Accordingly, policy expectation errors have been large and have only recently started to diminish.

7 Estimates of the natural interest rate for the euro area: an update

• More
  The natural rate of interest, r* (or “r-star”), is defined as the real rate of interest that is neither expansionary nor contractionary.
• [15] In the wake of the 2008 global financial crisis, real interest rates (as measured by deducting inflation expectations from a nominal rate of interest) slumped to exceptionally low levels in advanced economies, including the euro area.

8 Fiscal policy measures in response to the energy and inflation shock and climate change

• This box provides estimates and projections of discretionary fiscal measures taken by euro area governments relating to the energy crisis, high inflation, and climate change, updated as part of the December 2023 Eurosystem staff macroeconomic projections.
• More
  The discretionary fiscal measures to support households and companies in response to the energy price and high inflation shocks are projected to largely wind down in the coming years.
• The share of subsidies in total energy and inflation support measures is expected to fall significantly in 2024 and to be negligible as of 2025.

1 The Eurosystem policy response to developments in retail payments