The economic outlook for the euro area

The Brookings Institution

Washington D.C.

16 October 2019

Philip R. Lane Member of the Executive Board

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HICP and HICP excluding food and energy (year-on-year percentage change)

Sources: Eurostat. Last observation: September 2019 (flash estimates).

Inflation developments

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1999 2001 2003 2005 2008 2010 2012 2014 2017 2019

HICP HICP excluding food and energy

0.9

1.0

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Option-implied distribution of average inflation over the next five years (percentages)

Sources: Bloomberg, Thomson Reuters and ECB staff calculations. Notes: Probabilities implied by five-year zero-coupon inflation options, are smoothed over five business days. Risk-neutral probabilities may differ significantly from physical, or actual, probabilities. Latest observation: 4 October 2019.

0

10

20

30

40

50

60

70

80

90

100

2011 2013 2015 2017 2019

Below 0% Between 0% and 1.5%Between 1.5% and 2.0% Between 2.0% and 2.5%Above 2.5%

Indicators of market-based inflation expectations

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Supply breakdown (quarter-on-quarter; percentage changes changes; pp contributions)

GDP and sectoral breakdown

-0.20

0.00

0.20

0.40

0.60

0.80

GDP Industry Construction Services

2016Q4-2017Q4 2018Q1-2019Q1 2019Q2

Source: Eurostat, ECB Staff calculations. Note: The contributions of agriculture and taxes less subsidies on production are not shown. Last observation: 2019Q2.

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Manufacturing-services activity (5-year rolling-window correlations)

Sources: Eurostat, ECB staff calculations. Note: Correlations are computed for year-on-year growth rates with manufacturing value added. Shaded areas indicate the CEPR recession periods (2008Q3-2009Q2, 2011Q3-2013Q1). Business services comprises H52, H53, J62, J63, M69_702, M71, M73, N78, N80, N81.2 and N82 and accounts for about 14% of total value added. Latest observation: 2019Q2.

Manufacturing and services activity

-0.25

0.00

0.25

0.50

0.75

1.00

2007 2009 2011 2013 2015 2017 2019

Market services Business services

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45

50

55

60

65

2014 2015 2016 2017 2018 2019

Composite output Manufacturing outputServices business activity

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Purchasing managers’ index of manufacturing and services output (diffusion index)

Chart 22

Source: Markit. Note: For each variable, the index is the sum of the percentage of higher responses and half the percentage of no change responses. The indices vary between 0 and 100, with a reading above 50 indicating an overall increase compared to the previous month, and below 50 an overall decrease. Latest observation: September 2019.

Development of purchasing managers’ index

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Unemployment rate and wages (lhs; year-on-year percentage change, rhs; percentage)

Sources: Eurostat and ECB staff calculations. Latest observation: 2019Q1 for compensation per employee and 2019Q2 for unemployment.

Labour market developments

6

7

8

9

10

11

12

130.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1999 2003 2007 2011 2015 2019

Compensation per employee Unemployment rate(inverted, right-hand scale)

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Actual and projected HICP inflation (year-on-year percentage change)

Sources: ECB and Euro system staff macroeconomic projections. Note: The grey area indicates the current projection period. Last observation: Q3 2019.

Actual and projected inflation

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2013 2014 2015 2016 2017 2018 2019 2020 2021

Sep-19 projectionDec-18; Mar-19: Jun-19 projectionsActual HICP

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Euro area and US long-term yields (percentage per annum)

Chart 25

Sources: Bloomberg and ECB. Latest observation: 8 October 2019.

Euro area and US longer-term yields

1.0

1.5

2.0

2.5

3.0

3.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2016 2017 2018 2019

Euro area 10-year overnight index swap rateUS 10-year Treasury yield (right-hand scale)

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The Governing Council decided to:

• lower the DFR by 10bps

• strengthen the forward guidance on rates: “we expect the key ECB interest rates to remain at their

present or lower levels until we have seen the inflation outlook robustly converge to a level sufficiently

close to, but below, 2% within our projection horizon, and such convergence has been consistently

reflected in underlying inflation dynamics”

• restart net purchases at a monthly pace of €20 billion, expecting them to run for as long as necessary to

reinforce the accommodative impact of our policy rates, and to end shortly before we start raising the key

ECB interest rates

• reconfirmed the forward guidance on reinvestments

• change the modalities of the TLTRO-III: removing the 10bps spread and extending maturity to 3 years

• introduce a two-tier system for reserve remuneration

Monetary policy decisions 12 September 2019

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Impact of ECB non-standard measures on the term structure of interest rates 2014-18

(percentage points per annum)

Source: Rostagno, Altavilla, Carboni, Lemke, Motto, Saint-Guilhem, Yiangou (2019), forthcoming. Notes: NIRP = negative interest rate policy; FG = forward guidance; APP = asset purchase programme. The chart shows the impact of ECB non-standard measures on the GDP-weighted aggregate of euro area sovereign bond yields. The APP impact is due to Eser, Lemke, Nyholm, Radde, and Vladu (2019). The impact of NIRP and forward guidance is derived from counterfactual analysis of OIS forwards based on option-implied densities.

Term structure effects of the ECB’s policy measures 2014-2018

0.0

0.4

0.8

1.2

1.6

0.0

0.4

0.8

1.2

1.6

2y 5y 10y 2y 5y 10y 2y 5y 10y 2y 5y 10y 2y 5y 10y

2014 2015 2016 2017 2018

NIRPFGAPP

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EONIA forward curves and deposit facility rate (percentages per annum)

Sources: Thomson Reuters and ECB calculations. Last observation: 10 October 2019.

Actual and expected short-term rates

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

Dec-14 Dec-16 Dec-18 Dec-20 Dec-22 Dec-24

Realised EONIALatest forward curve (10 Oct 19)End-2014 forward curve (22 Dec 14)Deposit facility rate

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Term premia impact across maturities (basis points)

Source: Based on Eser, Lemke, Nyholm, Radde and Vladu (2019). Notes: The chart shows by how much the term premium component of sovereign euro area yields with maturities of one year to ten years are estimated to be compressed due to the APP, at the time of the launch of the APP (Q1 2015), as well as the previous end of net purchases in December 2018.

The asset purchase programme

-100

-75

-50

-25

0

25

1 2 3 4 5 6 7 8 9 10

Launch of the programme (2015Q1)

Previous end of net purchases (2018Q4)

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Distribution of NFC deposit rates across MFIs in July 2019

(x-axis: deposit rates in percentage per annum, y-axis: frequencies in percentage, weighted by volumes)

Volumes of bank deposits and loans comparing banks that charge negative rates to those that do not

(total volumes; May 2014 = 1)

Source: Altavilla, Burlon, Giannetti and Holton (2019). Notes: The chart refers to banks in all euro area countries. Information on deposit rates charged at the individual bank level is based on iMIR data, while data on loan and deposit volumes are based on iBSI data. Total volumes for loans and deposits are normalised to the level in May 2014. NFPS stands for non-financial private sector. Latest observation: July 2019.

Negative rate pass-through

-0.6

-0.4

-0.2 0.0

0.2

0.4

0.6

0.8

1.0

Non-vulnerable countries

0

25

50

75

100

-0.6

-0.4

-0.2 0.0

0.2

0.4

0.6

0.8

1.0

Vulnerable countries

0.8

1.0

1.2

1.4

1.6

2013 2015 2017 2019

DepositsNever negative Sometimes negative

0.9

1

1.1

1.2

1.3

1.4

2013 2015 2017 2019

Loans to NFPS

Sources: ECB, ECB staff calculations. Notes: Deposit rates on outstanding amounts as reported by individual banks for each of the available product categories, weighted by outstanding amounts. Vulnerable countries include IT, ES, PT, GR, IE, SI, CY. Non-vulnerable countries include the remaining euro area members. Latest observation: July 2019.

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Composite bank funding costs (percentage per annum)

Composite lending rates and 2y OIS (percentage per annum)

Sources: Markit iBoxx, ECB. Notes: Composite funding rates are the weighted cost of deposits and market debt funding. Deposit rates are on new business and bond yields include both high yield and investment grade debt. Latest observations for composite and deposit rates: July 2019; for bond yields: 8 October 2019.

Sources: ECB, ECB staff calculations. Latest observations: July 2019 for lending rates;10 September 2019 for OIS.

Bank funding costs and lending rates

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2013 2014 2015 2016 2017 2018 2019

Deposit rates Bank bond yields Composite funding cost

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

1.5

1.6

1.7

1.8

1.9

2.0

2017 2018 2019

NFCsHHs for house purchase2y OIS (right-hand scale)

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Impact of TLTRO on lending rates (percentage points, deviations from September 2014)

Impact of TLTRO on lending volumes (notional stock, September 2014=1)

Sources: ECB iMIR and ECB staff calculations. Notes: NFC lending rates are on outstanding loans to non-financial corporations weighted by volume. The chart shows average rates across bidders and non-bidders in deviation from rates in September 2014. “Vulnerable countries” are Ireland, Greece, Spain, Italy, Cyprus, Portugal and Slovenia. “Other countries” are all the remaining euro area countries. Last observation: June 2018.

Sources: ECB iBSI and ECB staff calculations. Notes: The chart shows the notional stock of loans to NFCs across bidders and non-bidders relative to September 2014. “Vulnerable countries” are Ireland, Greece, Spain, Italy, Cyprus, Portugal and Slovenia. “Other countries” are all the remaining euro area countries. Last observation: June 2018.

Impact of TLTRO on lending rates and lending volumes

-1.5

-1.0

-0.5

0.0

0.5

-1.5

-1.0

-0.5

0.0

0.5

2013 2015 2017

Non bidders Bidders

-1.5

-1.0

-0.5

0.0

0.5

-1.5

-1.0

-0.5

0.0

0.5

2013 2015 2017

Other countries

Vulnerable countries

0.8

0.9

1.0

1.1

1.2

0.8

0.9

1.0

1.1

1.2

2013 2015 2017

Non bidders Bidders

0.8

0.9

1.0

1.1

1.2

0.8

0.9

1.0

1.1

1.2

2013 2015 2017

Other countries

Vulnerable countries

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Excess liquidity projection and calibration of a two-tier system

(€ bn)

Relationship between excess liquidity and the EONIA - MRO spread (horizontal: €bn; vertical: basis points)

Source: ECB staff calculations. Notes: The solid black line denotes realized excess liquidity and the dotted black line denotes projected excess liquidity including the predicted take-up for TLTRO-III (recalibrated at the September Governing Council meeting) and the renewed net asset purchases of EUR 20bn per month. The exempt excess liquidity is based on a two-tier system with an MRR multiplier of 6 in line with the Governing Council’s September. Latest observation: September 2019.

Source: ECB. Notes: The EONIA-MRO spread is normalised to the width of the corridor (50bps), where the normalisation is calculated as 50 𝑏𝑏𝑏𝑏𝑏𝑏

𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 ∗ 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 of EONIA to MRO.

Latest observation: September 2019.

A tiering system for the remuneration of reserves

0

500

1000

1500

2000

2500

0

500

1000

1500

2000

2500

Jan Mar May Jul Sep Nov

Unexempted Excess LiquidityExcess Liquidity projectionExcess LiquidityExempted Excess Liquidity

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Contribution of ECB non-standard measures to real GDP growth 2014-18

(percentage per annum)

Contribution of ECB non-standard measures to HICP inflation 2014-18

(percentage per annum)

Source: Rostagno, Altavilla, Carboni, Lemke, Motto, Saint-Guilhem, Yiangou (2019), forthcoming. Notes: The chart shows the impact of ECB non-standard measures on macro variables based on a macroeconomic model with financial variables conditioning on the yield curve impact shown on the previous slide

Source: Rostagno, Altavilla, Carboni, Lemke, Motto, Saint-Guilhem, Yiangou (2019), forthcoming. Notes: The chart shows the impact of ECB non-standard measures on macro variables based on a macroeconomic model with financial variables conditioning on the yield curve impact shown on the previous slide.

Contribution of ECB non-standard measures to growth and inflation

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2014 2015 2016 2017 2018

TLTRO NIRPFG APPReal GDP growth Counterfactual

-0.5

0.0

0.5

1.0

1.5

2.0

-0.5

0.0

0.5

1.0

1.5

2.0

2014 2015 2016 2017 2018

TLTRO NIRPFG APPHICP inflation Counterfactual

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• the euro area is facing a more extended slowdown than previously expected

• the convergence of inflation towards the inflation aim has recently slowed and partly reversed

• the ECB’s monetary policy measures remain effective in fostering a reacceleration of growth and,

thereby, inflation convergence

• a highly accommodative stance of monetary policy will be necessary for a prolonged period of time

• the more fiscal policy contributes to boosting long-term growth potential and providing cyclical

stabilisation, the quicker will be the effects of monetary policy interventions on the economy and inflation

Conclusions

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