THE EURO AREA: ECONOMIC SITUATION, PROSPECTS AND CHALLENGES Óscar Arce Director General Economics, Statistics and Research Banco de España Global Interdependence Center Central Banking Series Madrid, 218 November 15th
The euro area: economic situation, prospects and challenges OUTLINE 1. The slowdown of economic growth in the euro area 2. Growth and inflation prospects 3. Rising risks 4. Main challenges 2
The slowdown of economic growth in 218 Following strong momentum in 217, growth in the EA is slowing: Average qoq growth stood near,7 in 217;,3 in the first three quarters in 218 (,15 in Q3). The slowdown has been larger than anticipated, and affects all large euro area countries GDP QUARTERLY GROWTH AVERAGE GDP QUARTER-ON-QUARTER GROWTH 1, 1,5,8 1,3,7,75,5 1,1,9,7,6,5,5,4,25,3,3,1 -,1 -,3,2,1 -,25 214 215 216 217 218 -,5 EMU DE FR IT ES GDP FORECAST PMI (Right-hand scale) Sources: Eurostat, European Commission, ECB and IHS Markit. (a) Nearest ECB forecast. Last March, June and September ejercises for Q1, Q2 and Q3, respectively 217 218 Q1-Q3 3
External Factors stand behind the larger than expected moderation Modest growth during 218 largely reflects global trade moderation: Net trade contribution to growth has been negligible Transitory factors could have also played a role in some countries (weather, strikes, diesel ) GLOBAL PMI REAL GDP GROWTH AND CONTRIBUTIONS FIRST HALF OF 218 55 1,2, PP 54 53 52 51 5 1,,8,6,4 49,2 48 213 214 215 216 217 218 OBSERVED BMPE DEC-17 MANUFACTURING NEW EXPORT ORDERS DOMESTIC DEMAND NET EXPORTS GDP Sources: ECB, Eurostat and IHS Markit. Last date: 218, October for PMI 4
Domestic fundamentals (I): Labour market developments Domestic fundamentals remained resilient, underpinning economic growth Job creation has been key in the expansion and is expected to remain robust Labour market improvements are starting to be transmitted to wage growth. The rise in wages is broad-based by sectors and countries. EMPLOYMENT, UNEMPLOYMENT AND PMI INDEX,6,5,4,3,2,1 -,1 -,2 13 12 12 11 11 1 1 9 9 COMPENSATION PER EMPLOYEE GROWTH DESCOMPOSITION Breakdown based on Phillips Curve estimation (Deviations from the mean),6,4,2 -,2 -,4 -,6 -,8-1, -,3 213 214 215 216 217 218 EMPLOYMENT (quarter-on-quarter growth) UNEMPLOYMENT RATE (Right-hand scale) PMI ASSESSMENT OF EMPLOYMENT (Right-hand scale) COMPENSATION PER EMPLOYEE Source: Eurostat and IHS Markit. Last date: 218 Q2 to employment and compensation per employee, 218 September to unemployment and 218 October to PMI 8-1,2 211 212 213 214 215 216 217 218 RESIDUAL INFLATION UNEMPLOYMENT GAP PRODUCTIVITY 5
Domestic fundamentals (II): Household income Strong job creation and (recent) increases in wages are supporting household income, though rising inflation is dampening household purchasing power Household consumption growth has closely followed income developments, with saving rates near historic lows (except in Germany) HOUSEHOLD GROSS DISPOSABLE INCOME (GDI) AND CONSUMPTION Annual growth rates 4 3 2 1-1 -2-3 9 1 11 12 13 14 15 16 17 18 CONSUMPTION (real terms) NOMINAL GDI REAL GDI Sources: ECB and Eurostat. Last date: 218, second quarter. 5 4 3 2 1-1 -2-3 -4 SAVING RATE Deviations from long-term average (1999-218 Q2) GDI -5 29 21 211 212 213 215 216 217 218 GERMANY FRANCE EURO AREA ITALY SPAIN 6
Domestic fundamentals (III): Favourable financing conditions Very loose financial conditions continue to support lending to the private sector, with loan rates at historical lows 4, BANK LOANS INTEREST RATES 8 5 BANK LOANS Annual growth rates 3,5 7 4 3 3, 6 2 2,5 5 1 2, 4-1 1,5 3-2 -3 1, 213 214 215 216 217 218 2-4 213 214 215 216 217 218 NON-FINANCIAL CORPORATIONS < 1MILLION NON-FINANCIAL CORPORATIONS > 1MILLION HOUSE PURCHASE CONSUMPTION (rhs) NON-FINANCIAL CORPORATIONS HOUSEHOLDS Sources: ECB. Last date: 218, September. 7
The role of monetary and fiscal policies Fiscal policy is expected to have a slight expansionary stance both in 218 and 219 Monetary policy will still provide substantial monetary stimulus in order to support a build-up of domestic price pressures over the medium term 2 1 FISCAL POLICY STANCE GDP pps of POTENTIAL GDP 2 1,8 MONETARY POLICY EXPECTATIONS Bloomberg survey Expected deposit rate Reinvestments (Nov. Survey) (Oct. Survey) of respondents 6,6 5,4 4-1 -1,2 3-2 -2 2-3 -3 -,2 1-4 -4 212 213 214 215 216 217 218 219 22 BALANCE CHANGE IN THE STRUCTURAL BALANCE (Right-hand scale) -,4 Q4Q1Q2Q3Q4Q1Q2Q3Q4 218 219 22 MEDIAN HIGH FORECAST LOW FORECAST 1 Y 2 Y 3 Y + 3 y Length full reinvestment period Source: European Commission (Autumn 218 forecast) and Bloomberg. 8
GDP prospects Domestic fundamentals will remain underpinning economic growth, above potential, although the slowdown in external trade and rising uncertainty will weigh in growth GDP GROWTH FORECAST 217 218 219 22 ECB September 18 2.5 2. 1.8 1.7 June 18 2.5 2.1 1.9 1.7 European Commission November 18 2.4 2.1 1.9 1.7 July 18 2.4 2.1 2. MFI October 18 2.4 2. 1.9 1.7 July 18 2.4 2.2 1.9 OECD September 18 2.5 2. 1.9 May 18 2.5 2.2 2.1 Survey Professional Forecasters October 18 2. 1.8 1.6 July 18 2.2 1.9 1.6 Consensus October 18 2.5 2. 1.8 1.4 September 18 2.5 2.1 1.8 Eurobarometer October 18 2.5 2. 1.8 1.6 September 18 2.5 2.1 1.8 3 2 1-1 REAL GDP GROWTH 12 13 14 15 16 17 18 19 2 QUARTER ON QUARTER GROWTH (RHS) ANNUAL GDP GROWTH POTENTIAL GDP GROWTH Source: Eurostat and European Commission. 1,5 1,,5 -,5 9
Inflation prospects Growth rates above potential and tightening labour markets support confidence on the sustained convergence of inflation towards the medium-term reference. Although core inflation is still hovering around 1. INFLATION FORECAST 217 218 219 22 ECB September 18 1.5 1.7 1.7 1.7 June 18 1.5 1.7 1.7 1.7 European Commission November 18 1.5 1.8 1.8 1.6 July 18 1.5 1.7 1.7 MFI October 18 1.5 1.7 1.7 1.8 April 1.5 1.5 1.6 1.8 OECD September 18 May 18 1.5 1.6 1.8 Survey Professional Forecasters October 18 1.7 1.7 1.7 July 18 1.7 1.7 1.7 Consensus October 18 1.5 1.7 1.7 1.7 September 18 1.5 1.7 1.6 Eurobarometer October 18 1.5 1.7 1.6 September 18 1.5 1.7 1.7 1.7 2,5 2, 1,5 1,,5 -,5 EURO AREA INFLATION 213 214 215 216 217 218 219 22 GENERAL EXCLUDING ENERGY AND FOOD Source: Eurostat and ECB. Last date: 218 October 1
Rising risks to the economic scenario Downside risks have related to both global and domestic factors have intensified: Protectionism tensions Most estimates of the impact of enacted tariff increases suggest limited effects for the euro area, but larger effects through confidence effects and postponement of investments cannot be discarded Global policy uncertainties and turmoil in emerging markets: Fiscal expansion in the US and the gradual normalization of Fed s monetary policy tightenf global financial conditions, with a stronger impact om highly indebted EMEs. Uncertainty about the degree of slack of the euro area economy: high levels of capacity utilization and some labour shortages point to possible supply side restrictions in some sectors/countries. Tensions in Italy: So far, contagion effects have been limited, but it cannot be ruled out that further bouts of uncertainty over the Italian fiscal situation might have more significant adverse effects in the future Risk of no deal for Brexit: it would entail important changes in trade relations after April 219 with potentially large impact on some financial market segments/insturments 11
Protectionism tensions Trade tensions have further increased in recent months. Most estimates of the impact of enacted tariff increases suggest limited effects for the euro area. But large indirect effects -through confidence and uncertainty leading companies to postpone or cancel investment projects- cannot be discarded REAL GDP IN TRADE TENSIONS SCENARIO (Long term percent deviation from control) -,1 -,2 -,3 -,4 -,5 -,6 -,7 -,8 EU TRADE POLICY The EU imposed tariffs to $3.3 billion worth of US goods in response to iron and steel tariffs US-EU TRADE AGREEMENT o Work towards a free trade area, with zero tariffs on non-auto industrial goods, zero non-tariff barriers and zero subsidies on non-auto industrial goods. EU will increase imports of gas and soya beans from the US. o Work together to reform the WTO and to protect intellectual property rights o The deal lacks of details and specifics. -,9-1, USA CHINA EURO AREA JAPAN WORLD TARIFFS ENACTED POTENTIAL TOTAL EFECTS (a) Source: IMF, October 218. (a) Effects of tariffs enacted plus other potential retaliation measures, confidence effects and market reactions JAPAN- EU ECONOMIC PARTNERSHIP AGREEMENT o Removal of the majority of tariffs and opening of agricultural and services markets. o For the first time, the agreement includes a specific commitment to the Paris climate change. 12
Global policy uncertainty and financial conditions 3,5 3, 2,5 2, 1,5 1,,5 Fiscal expansion in the US together with tighter monetary policy is leading to a tightening of global financial conditions. Highly indebted EMEs have been the most vulnerable, with strong depreciations of their currencies The euro has significantly appreciated in nominal effective terms since 217 1 YEAR INTEREST RATES -,5 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 USA GERMANY 125 123 121 119 117 115 113 111 19 17 15 13 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Sources: ECB and IMF GSFR October 218. Last date: November, 13. EXCHANGE RATE 1 = 1999 Q1 $/ Euro Effective Echange Rate EER-38 DOLLAR (Right-hand scale) 1,25 1,23 1,21 1,19 1,17 1,15 1,13 1,11 1,9 1,7 1,5 1,3 GLOBAL FINANCIAL CONDITIONS INDICES 2, 1,5 1,,5 -,5 TIGHTER CONDITIONS -1, S-12 S-13 S-14 S-15 S-16 S-17 S-18 USA Other Systemically Important Advanced Economies CHINA Other Systemically Important Emerging Economies 13
Uncertainties related to the extent of supply side constrains There is uncertainty regarding the degree of slack of the economy: high levels of capacity utilization and some labour shortages point to possible supply side restrictions But, there are some signals of remaining slack in the labour market, as broader definitions of unemployment reflect. 9 EURO AREA.CAPACITY UTILISATION AND FACTORS LIMITING ACTIVITY 6 25 EURO AREA.BROADER ESTIMATIONS OF UNDERUTILIZATION OF LABOR BROADENED ACTIVE POPULATION 85 5 2 8 4 15 75 7 65 3 2 1 1 5 6 CU Employ_ Left-hand ment scale Demand Equipment Financing None RANGE Q3 218 AVERAGE (a) 28 214 217-218 UNDEREMPLOYED LOOKING FOR WORK, BUT NOT AVAILABLE AVAILABLE, BUT NOT LOOKING FOR WORK UNEMPLOYED Sources: European Commission and Eurostat. Last date: 218, October for opinion indicators and September 218 for unemployment. (a) Average since 1999 for capacity utilization and since 24 for factors limiting activity. 14
Italy High public debt and low-growth are a notable source of vulnerability. Rising sovereign yields and the reactivation of sovereign-bank risk nexus could eventually offset the positive effects arising from fiscal expansion So far, contagion effects towards other euro area countries have been limited, but further bouts of uncertainty cannot be ruled out 8, 1 YEAR SOVEREIGN YIELDS 25 pb ITALY. SOVEREIGN-BANK NEXUS CDS 5-YEARS 7, 6, 2 5, 4, 15 3, 2, 1 1, 5-1, 7 8 9 1 11 12 13 14 15 16 17 18 GERMANY FRANCE ITALY SPAIN Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 SOVEREIGN BANK SECTOR Sources: ECB and IFS Datastream. Last date: November, 13. 15
The impact of Brexit under a WTO scenario Trade channel Scenario WTO Variable GDP Inflation Employment Country 5 yr Horizon UK -4.4-2.2-2.6 Euro Area -.3 -.1 -.1 US.3 -.1.1 Japan.1 -.1. China.1 -.1. GDP World Trade (Exports) World -.1-2.8 GDP: Accumulated difference from baseline scenario. Inflation: Accumulated level difference from baseline scenario. Employment: Accumulated difference from baseline scenario. Source: Own simulations carried out with NiGEM Migration channel Scenario WTO Variable GDP Inflation Employment Country 5 yr Horizon UK -.9.3-1.2 Euro Area...2 US... Japan... China... GDP World Trade (Exports) World.. GDP: Accumulated difference from baseline scenario. Inflation: Accumulated level difference from baseline scenario. Employment: Accumulated difference from baseline scenario. 16
The euro area economy challenges Monetary policy normalisation will need to be proceed with caution to ensure a continued sustained convergence of inflation towards the medium term reference, On fiscal policy, the economic expansion and low interest rates call for rebuilding fiscal buffers, particularly in countries with high public debt. Meeting low productivity and demographic challenges will require further efforts on structural reforms to boost potential long-term growth, improve shock-absorbing capacity and reduce vulnerabilities. Culmination of Brexit negotiations: the terms of the separation and the nature of the future UK-UE relationship are yet to be defined In the medium term, the stability of the Eurozone will require deeper integration: - The institutional reform agenda must progress faster through parallel risk-reduction and risk-sharing measures while enhancing national responsibility. - The key priorities are completing the banking union, advancing on the capital market union agenda and designing supranational instruments to help to cope with asymmetric shocks and to support monetary policy in the event of big negative shocks. 17