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Globaleconomyandeuroarea

43Economicandfinancialdevelopments ❙ GloBAl EcoNoMy AND EuRo AREA ❙

1. Globaleconomyandeuroarea

1.1 Modestbutstableglobalgrowth

In 2016, theglobaleconomymaintainedmodestgrowthdespiteahighlyuncertainenvironment.Followingahesi‑tantstart,thereweresignsofgrowingmomentuminthesecond half of the year. Supported by monetary policyaccommodation and the continuing low energy prices,theadvancedeconomiesdisplayedsomeresiliencedespite

the fears aroused by Brexit in particular. Therewas thusonly a slight dip in growth in the euro area, the UnitedKingdom and Japan. Conversely, there was a markedslowdownintheUnitedStates.Intheemergingeconomiesand commodity-exporting countries, growth was stable,butverywidevariationspersistedbetweencountries.Pastreductionsincommoditypricesandgenerallymodestwageincreasescontinuedtorestraininflationworldwide.

Table 1 GDP OF THE MAIN ECONOMIES

(percentage changes in volume compared to the previous year, unless otherwise stated)

p.m. Contribution to

global GDP growth

p.m. Share of

global GDP (1)

2014

2015

2016

2016

2010

2016

Advanced countries . . . . . . . . . . . . . . . . . . . . . . . . . 1.9 2.1 1.6 0.7 46.3 41.9

of which :

United States . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 2.6 1.6 0.3 16.8 15.6

Euro area . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1 2.0 1.7 0.2 13.7 11.9

Japan (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . −0.3 1.2 0.9 0.0 4.9 4.1

United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . 3.1 2.2 2.0 0.0 2.5 2.3

Emerging countries . . . . . . . . . . . . . . . . . . . . . . . . . 4.6 4.1 4.1 2.2 53.7 58.1

of which :

China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.3 6.9 6.7 1.1 13.9 17.9

India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.2 7.6 6.6 0.5 5.9 7.3

Russia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.7 −3.7 −0.6 0.0 3.6 3.1

Brazil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.1 −3.8 −3.5 −0.1 3.2 2.6

World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 3.2 3.1 3.1 100.0 100.0

p.m. World trade (3) . . . . . . . . . . . . . . . . . . . . . . . . . 3.8 2.7 1.9

Source : IMF.(1) According to the IMF definitions and calculated on the basis of purchasing power parities.(2) The data for 2015 and 2016 take account of the switch from the System of National Accounts 1993 to System of National Accounts 2008 and the updating of the reference year

from 2005 to 2011. The Japanese authorities made these changes in December 2016.(3) Average of exports and imports of goods and services.

44 ❙ ECONOMICANDFINANCIALDEVELOPMENTS ❙ NBB Report 2016

Stabilisation in the emerging economies

China encountered no major problems in continuingtorebalance itseconomyinfavourofdomesticgrowthbased on the strengthening of consumption and a gradual shift in activity from industry towards services.GDP growth dipped again slightly, to an average of6.7% in the first three quarters of 2016, down from6.9%in 2015.Butitremainedrobustandstayedwithinthe official target range of between 6.5% and 7%.The strong credit expansion invigorated the propertymarket, while the additional fiscal stimulus measuresbolstered consumption andgave a significant boost topublic investment. In contrast, the growth of privateinvestmentweakened considerably, despite a revival inresidentialinvestment.Thatslowdown,reflectedinafallintotal investment, ispartlyduetotheincreasedshareof services in theChineseeconomy–asmany servicesarenotopentoprivatecapital–andtoexcesscapacityinsomeindustrialsectors.Netexportscontractedsharplyowingtoanaemicglobaldemandandthecountry’slossofcompetitivenessinlowvalueaddedsectors.

Monetary policy, which has been gradually easedsince 2014,remainedexpansionaryin 2016.ThePeople’sBank of china still faces the challenge of supporting the economy while safeguarding financial stability. Againstthebackdropofstrongcreditexpansionwhichhasfuelledthe rapid rise in corporate debt and driven up propertypricessignificantlyinsomeregions,itchosetokeepitskeyinterestratesforloansanddepositsunchangedat4.35%and1.5%respectively.Inaddition,itmadeonlyonead‑justment to the reserve requirement coefficient, cuttingitfrom17.5%to17%inMarch.Inordertocombatthecountry’s debt problems, the central government intro‑duced policies aimed at supporting the debt restructuring of local authorities and public enterprises.

Since the US Federal Reserve was expected to raise itskeyinterestrates,thecapitaloutflowfromChinaalreadyapparent in 2015continued,varying in intensityaccord‑ingtochangesinthefinancialmarkets’perceptionoftheeconomicsituationinChina. Inthesecircumstances,theexchangerateremainedunderpressure.Thus,attheendof 2016,therenminbislumpedtoitslowestlevelagainsttheUSdollarinmorethaneightyears.ThePeople’sBankofChinadippedheavilyintoitsexchangereservestosup‑portthedomesticcurrency.Butitstillhadtoresolvetoac‑companyitsdepreciationbygraduallyreducingitscentralrate against the us dollar.

In the commodity-exporting countries, economic activ‑ity in general continued to suffer from the weaknessof demand and hence the low level of prices for those

products, due in particular to the ongoing transition oftheChineseeconomy.Brazil languishedinadeepreces‑sionwhichhadbegunin 2015,exacerbatedbyapoliticalcrisis that seriously dented confidence in the country.However,theslowdowninactivityseemedtoeaseduringtheyear,inthewakeofarecentriseincommoditypricesandaslightexpansionofexports,resultingfromthepastdepreciationof the real.TheRussianeconomy,draggeddownbythefall inoilpricesandtheinternationalsanc‑tionsimposedsincemid-2014inresponsetotheconflictinUkraine,showedsignsofstabilisationin 2016follow‑ing the rise in crude oil prices. Finally, Indiamaintainedsound economic growth supported by an improvementinthetermsoftrade,afallininflation,andanumberofreformsfavourabletothebusinessclimate.Nevertheless,thegovernment’sdecisionon8 Novembertodemonetisethe500 and1000 rupeedenominationstoputastoptotheinformaleconomymayhavecurbedeconomicactivityfromtheendoftheyear.

The advanced economies remained resilient

Whilethedollar’sappreciationandthefallinoilpriceshadputatemporarybrakeonexportsandinvestmentattheendof 2015and inearly 2016, theAmericaneconomygainedmomentum from the thirdquarter. The strongerGDPgrowthwasbasedvery largelyonamarkedexportrecoveryand,toalesserextent,fasterstock-buildingandarevivalinfederalgovernmentspending.Incontrast,pri‑vatebusinessinvestmentremainedweakwhileconsumerspending,which is still themainengineofactivity,con‑tinuedtorisesteadily.Itwassupportedinparticularbyastrengtheninglabourmarketandfurtherwageincreases.Theunemploymentratedroppedbelow5%,whilehourlywages increased towards the end of the year at theirstrongest rate since 2009. Labour market participationstabilised, thoughat just under63%at the endof theyear,itremainedbelowitspre-crisislevelofaround66%.

Despite signs of gradual improvement on the jobsmar‑ket, the Federal Reserve adopted a prudent approach.In the face of uncertainty over the real dynamism ofthe economy, and as inflation still remained below itstargetof2%,themembersoftheFederalOpenMarketCommittee(FOMC)leftthekeyinterestratesunchangedforalmosttheentireyear.Thestatusquowhichhaslongprevailedcontrastswiththeexpectationsconcerningthefederal funds rates published in December 2015,whenthe Federal Reserve had raised its key interest rates forthe first time since 2008, from a range of 0.00-0.25%to0.25-0.50%.Atthattime,allmembersoftheFOMCwereexpectingat least two rate increasesduring 2016.Nonetheless, takingaccountof theactualandexpecteddevelopmentsonthelabourmarketandontheinflation


front, theFedeventually increased its interest ratebandby 25 basis points in December 2016. It also foreseesfurtherrisesin 2017.

Thefiscalpolicystancewaseasedslightlyduringthefiscalyear 2016.Thepublicdeficitgrewfrom4.4%to5%ofGDPbetweenOctober 2015andSeptember 2016,pro‑pellingthepublicdebtto115.6%ofGDP.

InJapan,theeconomymaintainedmodestgrowthover‑all, underpinnedbybuoyant consumptionas a resultofthegradualimprovementinemploymentandhouseholdincomes. InNovember, theunemployment ratestoodat3.1%,afterhavingdroppedbackto3%inJuly,itslowestlevelsinceJanuary1995.However,thisfavourablepictureneedstobequalifiedslightlyasitstemsfrombothariseindemand for labour and a contraction of the labour force. Japanese economic growth benefited from extremelyfavourablefinancial conditions andgovernment supportmeasures. Conversely, it was restrained by weaker de‑mandfromtheemergingeconomies,particularlyinAsia,andtheappreciationoftheyen,twofactorsthatconsid‑erablydepressedJapan’sexports.

DespitetherelativelyhealthystateoftheJapaneseecon‑omy, inflation still returned tonegativefigures in 2016.The Bank of Japan therefore maintained its asset purchase programme aimed at expanding the monetary base bysome80000 billionyen(oraround€615 billion)ayear.It also took various steps to ease its monetary policyfurther.Inviewoftheworldwidefinancialtensionatthebeginning of the year and the uncertainty surroundingthe economic outlook in the emerging countries, theinterestrateondepositswasthustakenintonegativeter‑ritoryat–0.1%,attheendofJanuary.Inaddition,anewmonetarypolicyframeworkwasintroducedattheendofSeptember,aimedinparticularatraisinginflationexpecta‑tionstowardsthetargetof2%,butalsointendedtopre‑ventanydecline inthefinancialsector’sprofitability inalowinterestrateenvironment.Thatframeworkcomprisestwomainelements.Thefirstaimsto influencetheyieldcurvebytightercontroloverlong-andshort-terminterestrates.Thesecondisaformalcommitmenttoexpandthemonetarybaseuntilinflationremainsabovethe2%tar‑get“inastablemanner”.TheBankofJapanalsostatedthat it did not rule out the option of cutting its main policyratefurther,andifnecessaryadjustingitsassetpur‑chases.Turningtothebudget,theconsolidationprocesswhichbeganin2013 wasinterruptedinfiscalyear 2016.Threefiscalstimulusplanswereproduced,whileafurtherincrease inVAT,originallyscheduledforApril 2017,waspostponedtoOctober 2019.Inthatcontext,theprimarydeficithoveredaround5%ofGDPandthegrosspublicdebtexceeded230%ofGDP.

In theUnitedKingdom, the referendumon23 JuneanditsoutcomeinfavourofBrexithadnosignificantadverseeffectoneconomicactivity.QuarterlyGDPgrowth,whichcameto0.6%inthethirdquarter,washardlyany lowerthan in thesecondquarter,andconsiderablyhigher thanexpected. Thus, supported by the vigour of the servicessectorwhichrepresentsalmost80%oftheeconomy,the2%activitygrowthover 2016asawholewasonlyslightlybelow the 2015 figure. The unemployment rate, whichstood at 4.8% inNovember, dropped to its lowest levelfortenyears,thusstimulatingprivateconsumption.Thesefavourabledevelopmentsareprobablydue inpart to theBankofEngland’snewmonetarypolicymeasures.Atthebeginning of August, it cut its benchmark Bank Rate by25 basispointsto0.25%.Italsodecidedtostepupitstotalpurchasesofgovernmentbondsfrom£375 billion(around€509 billion)to£435 billion(around€590 billion),topur‑chase£10 billionworthofbondsissuedbynon-financialcorporations, and to introduce long-term refinancingoperations in order to ensure the effective transmission of itsmonetaryeasing tohouseholdsandbusinesses.Whilethe slump in sterling following the referendumdoes notseem to have produced benefits as yet for sectorsmoregearedtowardsexports,suchas industryandagriculture,it has brought higher inflation. Nonetheless, at 1.6% inDecember, inflation is stillwell below the target of 2%.AlthoughBrexit’smacroeconomic impacthasbeenminorsofar,itislikelytobepainfulinthelongterm.ThequestionmarkovertheformoffuturerelationsbetweentheEUandtheUnitedKingdomisexpectedtosubduenewinvestmentandjobcreation,andsomesignsofthatwerealreadyap‑parentin 2016.With thehigherbarrierstotrade,financial

CHART 1 LOWINFLATIONINTHEADVANCEDECONOMIES

(consumerpriceindex,changecomparedtothecorrespondingperiodofthepreviousyear)

2011 2012 2013 2014 2015 2016–2

–1

0

1

2

3

4

5

6

United Kingdom

Japan

United States

Euro area

Sources:EC,Japan’sMinistryofInternalAffairsandCommunications,U.S.Bureauof labor.


transactions and the movement of people that could result from Brexit, that uncertainty could thus ultimately curbeconomicgrowthinboththeUnitedKingdomanditstrad‑ing partners.

Growth of world trade slows again

Thegrowthofworld tradeslackenedpaceagain in 2016.Thatwasduemainlytoaslowdownoftradeintheemerg‑ingcountriesandinNorthAmerica.Theworldwidesluggish‑nessofeconomicactivity,andmorespecifically investment–thedemandcomponentwiththelargestimportcontent –,isconsideredtobeamajorreasonforthisslowergrowth.China’s transition to an economy geared to consumptionand services – and therefore less dependent on imports of rawmaterials andmachinery – and the decline in capitalspendingbycountriesexportingcommoditiesareprobablythe dominant factors here. Other reasons put forward toexplain theweaker expansion ofworld trade also includethe lack of progress in trade liberalisation – or an actual rise in protectionism as evidenced by the restrictions observedbytheWorldTradeOrganisation(WTO)–andthefactthatglobalvaluechainsarenolongerbeinglengthened,in con‑trasttotheirrapidextensionoverthepasttwodecades.

Rising commodity prices

While thepriceperbarrel ofBrent crudehaddroppedbelow $30 in mid-January, oil prices staged a strongrecovery throughout the first half of 2016, exceeding

the $50 mark during the summer. That rise was duelargelytoinvoluntaryproductionstoppagesthatreducedsupplies,thoughoversupplypersisted.Conflictsofvari‑ous kinds and difficult weather conditions interruptedproductioninanumberofmajoroil-producingcountriessuch as Libya, Nigeria, Venezuela and Canada. At thesametime,globaldemandprovedstrongerthanexpect‑ed,thoughwithoutregaining itsprevioushigh level. Inthesecondhalfoftheyear,oilpricesweremorevolatile.AttheendofNovember,theOPECcountriesagreedtocutproduction,andthatdroveoilpricesabove$50 perbarrel again.

Overall,pricesofcommoditiesexcludingenergyalsore‑cordedamodestriseinthefirsthalfoftheyear,beforestabilisingforatime.Thatincreaseisdirectlyrelatedtotherecoveryofenergyprices,asenergyisamajorinputboth for industrial raw materials and for agriculturalproduction.On topof that, foodpricesalso roseasaresult of disappointing harvests,while the increase inmetalprices likewise reflects a slight strengtheningofglobaldemand.Attheendoftheyear,thestatementsmade by the US President-elect concerning the intro‑duction of an infrastructure stimulus plan caused prices to surge in anticipation.

Highly favourable financial conditions

Supported by the accommodative monetary policy, fi‑nancialconditionsremainedveryfavourableoverall,even

CHART 2 FURTHERSLOWDOWNINWORLDTRADEAGAINSTTHEBACKDROPOFRISINGCOMMODITYPRICES

2011 2012 2013 2014 2015 2016–4

–2

0

2

4

6

8

10

12

14

2011 2012 2013 2015201425

45

65

85

105

125

145

165

185

2016

INTERNATIONAL TRADE(seasonally adjusted three-month moving averages of export and import volumes ; percentage changes compared to the previous year)

United States

Emerging countries

World Euro area Food commodities

Brent crude (per barrel)

Industrial commodities(index 2007 = 100)

COMMODITY PRICES(daily data, in $)

Sources:CPB,OECD,ThomsonReutersDatastream.


thoughthefinancialmarketsexperiencedseveralperiodsof turbulence.

A first bout occurred in late 2015 and early 2016,against the backdrop of new fears over the outlookforgrowthintheemergingcountries,especiallyChina.Acrosstheworld,Januarybroughtoneofthemostin‑tensesell-offsofriskyfinancialpositionssincethe2008financial crisis. The tension spread to the advancedeconomies and triggered a flight to quality. In thesecircumstances, the yield curve flattened while stockmarketsfalteredandriskpremiumswentup.Thesede‑velopmentswerefollowedbydisruptionthathadapar‑ticularimpactonthebankingsector,wheresharepricesfell sharply following publication of disappointing re‑sults. More generally, at the end of January, doubtsover the strengthof theAmerican recovery combinedwiththeBankofJapan’sdecisiontotakeitsovernightdepositrateintonegativeterritoryreinforcedthepros‑pect of a lengthy period of low interest rates, givingrisetofearsfortheprofitabilityofthefinancialsector.In parallel with brighter prospects for world growth,investors nevertheless soon regained their appetite for risk, which calmed volatility, supported asset pricesand lowered risk premiums. Sentiment regarding theemerging economies also improved as the advanced economies expected interest rates to remain low foraprolongedperiod, concernoverChina’sgrowthwasdiminishing, and commodity prices were picking up.The renewed flow of capital to those countries wasaccompanied by a strong stock market rally and theappreciationofthosecountries’currencies.

At theendof June, themarkets reactedstrongly to thevote in favour of the United Kingdom’s departure fromtheEU.Awaveofoptimismhaddrivenupassetpricesintheprecedingdays,buttheunexpectedreferendumresultcaused stock markets to tumble and depressed risk‑free yields.At the same time, sterling slumpedwhile theUSdollarandtheyenappreciated.Althoughtheinitialreac‑tion was strong, the turmoil subsided once the centralbanks stated that theywere ready to provide sufficientliquidity and, if need be, adopt new monetary easingmeasures such as those taken by the Bank of England.The tension then dissipated further against the back‑ground of a hesitant improvement in the outlook for the globaleconomy.Nonetheless,sterlingremainedlowand,following the reappraisal of the future monetary policystance,yieldsonsovereignbondsremainedclosetotheirhistoricalfloor.

The unexpected outcome of the American presidentialelectionon8 Novemberalso sent shockwaves throughboth thefinancialmarketsand thecommoditymarkets.The prospect of a massive infrastructure investment plan andtaxcuts,asadvocatedbythePresident-elect,hadabeneficialeffectonequitymarketsingeneral.Followingabriefpanicintheimmediateaftermathofthevote,stockmarkets rallied overall, especially in the United Stateswheretheindicesreachednewrecordlevels.Bycontrast,inviewoftheinflationriskofsuchafiscalstimulusplanfor the American economy in a virtually full employ‑ment situation, and therefore the likelihood that theFederalReservemight raise itskey interest rates sooner,investors turned away from the bond markets. Yields

CHART 3 HISTORICALLYFAVOURABLEFUNDINGCONDITIONS

–1

0

1

2

3

4

40

60

80

100

120

140

160

2011 2012 2013 20152014 2016 2011 2012 2013 20152014 2016

Germany US Japan

STOCK MARKET PRICES(daily data, indices 2007 = 100)

EURO STOXX (EA) S&P 500 (US)

Nikkei 225 (JP) Emerging countries

YIELD ON TEN-YEAR GOVERNMENT BONDS(in %)

source : Thomson Reuters Datastream.


onUS Treasuries climbed steeply during theweek aftertheelection,withtheten-yearyieldrisingbymorethan40 basispoints.TheriseinAmericaninterestratesspreadto other regions of the world, including the euro areaand the emerging economies.On the foreign exchangemarkets, the US dollar appreciated against most othercurrenciesandparticularly in relation to someemergingcurrenciessuchastheMexicanpesoandtheBrazilianreal.ThestatementsmadebythePresident-electsparkedfearsoverthefuturetradingrelationshipsoftheUnitedStates,and hence over the macroeconomic outlook for a number of countries. The changes at the top of the American ad‑ministrationrekindledtheuncertaintysurroundingfutureUS fiscalandtradepoliciesinparticular.

TheeuroremainedfairlystableagainsttheUSdollarformuchof 2016beforedepreciatingattheendoftheyear.OwingtothestatusquolongmaintainedbytheFederalReserve following the December 2015 rise in the keyinterestrates,thedollarwasnotexpectedtostrengthen.Conversely,thesinglecurrencyedgedupwardsineffec‑tive terms, but that rise masked divergences betweencurrencies.Itwasdueessentiallytoastrongappreciationagainstthepoundsterling,whichmorethanoffsetthedeclineagainsttheyenandemergingcurrenciessuchasthe Russian rouble and the Brazilian real. A significantfactor behind the strengthening of the yen until theautumnwas its status as a safe haven in an uncertainworld. The appreciation of the Russian rouble and the

Brazilian real reflectsboth the rise incommoditypricesand the more encouraging macroeconomic outlook for those countries.

1.2 Lowinflationinthecontextofamodestrecoveryintheeuroarea

Intheeuroarea,theslowbutsteadygrowthofeconomicactivity evident sincemid-2013 continued in 2016. ThevolumegrowthofGDPcameto1.7%asanannualaver‑age,downslightlyagainstthe 2015figureof2%.

Activitywassupportedbydomesticdemandonthebackof favourable funding conditions resulting in particular fromafurthereasingofEurosystemmonetarypolicyandaslightlyexpansionaryfiscalpolicy intheeuroareaasawhole. Employment was also dynamic. Conversely, theimpetusgeneratedbytheearlierdepreciationoftheeuroand the fall inoilprices in 2014and 2015fadedaway.External demand remained weak. There were also sev‑eral factors that continued to hamper the dynamismofthe economy. They included theongoingbalance sheetadjustment in a number of sectors and countries, theinsufficientimplementationofstructuralreforms–whichshouldboostpotentialgrowthinthelongtermandbol‑sterconfidenceanddemandintheshortterm–,andtheemergence of numerous uncertainties. Overall, produc‑tioncapacity remainedunderused in 2016, though toasteadilydiminishingdegree.Despitesubstantial jobcrea‑tion,unemploymentrateswerestillhigh,andtherecentinvestmentrevivalwasnotenoughtofillthegap.Thislastfactorisakeydeterminantoftheexceptionallyslowpaceofrecoveryfromthecrisis.

Among the sources of uncertainty affecting the globaleconomy, those relating to theUnitedKingdom’s futureexit fromtheEUwereofparticularconcern to theeuroarea.Sofar,however,theyhavehadlittleimpactoncon‑fidence.Despite the progress achieved in stabilising thefinancial system and strengthening the capitalisation ofEuropeanbanks,fearsaboutthebanks’profitabilityand,in some Member States, the high outstanding amountof non-performing loans on their balance sheet mayhave impeded their ability to fund business activity andinvestment.Finally,inaclimateofmistrustamongsomesectionsofthepopulation,asuccessionofscheduledelec‑tions and referendums made it harder for governments to conductpoliciesthathelptostrengthentheeconomyinthelongtermbutmayhavetransitionaleffectswhichareperceived as negative.

With growth still insufficient to put a rapid end to theunder-utilisationofproductioncapacity intermsofboth

CHART 4 EXCHANGERATESSUBJECTTOPOLITICALUNCERTAINTY

(exchangeratesagainsttheUSdollar,indices2011=100)

30

40

50

60

70

80

90

100

110

2011 2012 2013 2014 2015 2016

Euro area

Brazil

Russia

United Kingdom

China

Japan

source : Thomson Reuters Datastream.


labourandcapital,andanoutlookcloudedbynumerousuncertainties, inflation remained very low in the euroarea. Although the year-on-year change in the harmo‑nised index of consumer prices (HICP),which had beenzeroin 2015,didbecomeslightlypositiveagainin 2016atanannualaverageof0.2%,thatmeagrerisewasduemainlytothedisappearanceofthenegativebaseeffectsof theenergycomponent followingtherise inoilpriceson the international markets. Core inflation remainedstable throughout theyear,hoveringarounda low levelof0.9%.Withnostrengtheningofwagedynamicsintheeuro area, headline inflation shows no convincing signsofconvergingontheEurosystem’starget,namelyalevelbelow,butcloseto,2%overthemediumterm.

ExceptforGreece,allMemberStatescontributedtotheincreaseintheeuroarea’sGDP.Amongthemainecono‑mies, Ireland recorded the strongest growth. In Spain,growth remained robust while it gained momentum inGermany.Conversely,inPortugal,FinlandandItaly,eco‑nomicexpansionwaswellbelowtheeuroareaaverage.InGreece,GDPdeclined,butlesssteeplythanduringthegreat recession.

Economicactivityintheeuroareawaspredominantlysup‑portedbyprivateconsumption,whichwasunderpinnedbysubstantialjobcreation,aidedinsomecountriesbytheeffectsofpastreforms.Togetherwithlowinflation,thesedevelopments increased the real disposable income of householdsdespitethecontinuingsluggishnessofwages.The household savings rate remained stable overall, in‑dicating that the gains in purchasing power were usedmainlyforconsumerspending.

Publicconsumption likewisemadeanon-negligiblecon‑tribution to growth in the euro area. Still, there aremarkeddifferencesfromonecountrytoanother.Insomecountries the growth of public consumption resultedfromadditionalexpenditureonaccommodatingrefugeesortighteningsecuritymeasures.InGermany,publiccon‑sumptiongrewtwiceasfastasGDP.

The increase in gross fixed capital formation was alsorelatively strong at 3.3%, similar to the 2015 figure. Itwas supported not only by favourable financing condi‑tions,butalsobyarecoveryinthegrossoperatingsurplusoffirms,whiletheuseofproductioncapacity improved.

CHART 5 LOWINFLATIONINTHECONTEXTOFAMODESTRECOVERYINTHEEUROAREA

2011 2012 2013 2014 2015 2016

–3

–2

–1

0

1

2

3

2011 2012 2013 2014 2015 2016

GDP (1)

Change in inventories

Net exports

Gross fixed capital formation

Public consumption

Private consumption

CONTRIBUTION TO ANNUAL GDP GROWTH(volume data ; percentage points, unless otherwise stated)

–1.0

–0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

INFLATION(HICP, percentage annual change)

Total excluding energy and food

Total

source : Ec.(1) Percentagechangecomparedtothecorrespondingquarterofthepreviousyear.


However,investmentwasheldbackbythestillmutedanduncertain demand outlook, particularly in regard to theglobaleconomyandtheemergingeconomiesatthestartoftheyear,butalsobytheprocessofdeleveragingintheprivate sector of some countries and the uncertainties that persistedin 2016.

ExpressedasapercentageofGDP,investmentintheeuroareaasawhole in 2016wasstillwellbelowtheaveragelevelrecordedinthepre-crisisyears.That investmentgapprimarily reflects the sharpdecline in theMember Statesseriously affected by the crisis. In Ireland, where invest‑menthadalreadybouncedback in2012, the investmentshortfall has now clearly been made up, and the ECestimates Ireland’s investment growth at 16% in 2016.Investment gave a substantial boost to the economy ofthe Netherlands and Spain, but also to slower-growingeconomiessuchasFinland,andevenGreece.Inmostcases,the largestcontributioncamefromcorporate investment,although in some countries – including the Netherlands,FinlandandGermany–investmentinhousingalsoplayedamajorpart.Conversely,inPortugal,thefallininvestmentinhousingandpublicinvestmentseriouslyhamperedgrowth.

The Investment Plan for Europe, and more particu‑larly theEuropeanFund forStrategic Investments (EFSI),have already produced concrete results. Proposed inNovember 2014bytheECPresident,Jean-Claude Juncker,thatplanwasintendedtotriggerinvestment.TheEFSIwascreated inorderto increasethecapacityforrisk-bearing

finance in the EU by providing, over a period of threeyears, guarantees forprojectfinancingby the EuropeanInvestmentBank(EIB)andtheEuropeanInvestmentFund(EIF).Duringthatperiod,the investmentplanwouldpo‑tentiallygenerateinvestmentamountingto€315 billion.The resourcesmadeavailableby theEFSIup to theendof 2016 could finance new investment totalling around€164 billion in theEUMemberStatesasawhole, thusmaking a significant contribution to themobilisation ofprivate investment. In December 2016, the Council de‑cidedtoextendthecapacityoftheEFSIintermsofbothdurationandfinancialresources.

Whiledomesticdemandwasquitebuoyantin 2016,asithadbeeninthepreviousyear,exportgrowthweakened.The sluggishness of external demand confronting theeuroareasincetheendof 2015persistedin 2016,inlinewiththeweaknessofglobaltrade.WhiletradewithintheEUwas relatively resilient, itbarelycompensatedfor thedecline inexportsoutsidetheEUduringthefirsthalfoftheyear,especiallyasthenominaleffectiveexchangerateoftheeuroappreciatedslightlyatthattime.However,theeurolostgroundfromNovemberonwards.

In parallel with modest activity growth, the situation on the euro area labour markets improved further in 2016

Job creation in the euro area and in most of the Member Stateswas fairly robust,which isnoteworthy in viewof

CHART 6 RECOVERYCONTINUESINTHEEUROAREABUTTHEREISSTILLASUBSTANTIALINVESTMENTGAP

EL PT ES IT IE FI AT NL DE FR BE EA–14

–12

–10

–8

–6

–4

–2

0

2

4

IE ES DE NL AT FR BE PT FI IT EL EA–1

0

1

2

3

4

5

2014 2015 2016

26.3

INVESTMENT AS A PERCENTAGE OF GDP (in percentage points)

GDP AT CONSTANT PRICES(percentage change compared to the previous year)

8.5

Gap in 2016 compared to the average in 1999-2006

Largest gap since 2009

source : Ec.


thesluggishexpansionofeconomicactivity.Onereasonfor that contrast may be a shift in the composition oflabour towards sectors such as services,which are rela‑tively labour-intensive and use more part-time workers.Theproportionofpart-timersincreasedconsiderablyafterthe2008 crisis,andcontinuedrisinguntil2013 when itlevelled out. It was driven up by involuntary part-timework and flexible employment contracts against thebackground of the poor and uncertain demand outlook. Thus,thenumberofhoursworkedperworkerfellsharplyduringtherecessionyears.

The unemployment rate for the euro area as a wholeedged slightly downwards to an annual average of10.1%,itslowestlevelsincetheendof2011.AlthoughthedivergencesinunemploymentratesbetweenMemberStateshavediminished,theyremainsubstantial,ascondi‑tions remaindifficult in the countrieshardesthit by thecrisis.Forinstance,inGreeceandSpain,the 2016unem‑ploymentrateswerestillmuchhigherthanin2007.Thereiscontinuingunder-employmentonthelabourmarketinmostothereuroarea countries. That isduenotonly totheunemployedbutalsotopeoplewhoareabsentfromthe labourmarket because of the limited job prospectsbut might enter the market if conditions improved. Itseems,though,thattheupwardtrendintheparticipationrate evidentbefore the crisis has recently been restoredto someextent.At theendof 2016, the labourmarket

participation rate for the population of working agereached73%.

Further correction of the macroeconomic imbalances in the euro area, but the vulnerabilities have not entirely disappeared

Themostvulnerablecountrieshavemademajorconsoli‑dationeffortssincethestartofthedecade,enablingthemto reinforce the sustainability of developments in theireconomies.Nonetheless,many countries still facedhighexternalorinternaldebtlevels,andtheprogressachievedonthatfrontwasrathermeagrein 2016.

Externally, after the substantial corrections alreadymadeinprecedingyears,theadjustmentofcurrentac‑countbalancescontinuedin 2016,yetitwasasymmet‑ricbetweentheMemberStates.Theeuroarea’scurrentaccountsurpluswiththerestoftheworld,whichhadbeenmarginalin2010,thusincreasedrapidlyto3.3%ofGDPin 2015and3.7%in 2016.Apartfromthere‑ductioninthedeficitsrelatingtonetimportsofpetro‑leumproducts,which benefited virtually all euro areaMember States following the fall in prices, that trendisduetotheeconomicadjustmentsincountrieswhichhadsubstantialdeficitsbeforethecrisis,combinedwiththe persistent or even increasing sizeable surpluses in other countries.

CHART 7 LABOURMARKETSITUATIONIMPROVES,BUTTHEREISSTILLSCOPEFORABSORBINGUNDER-EMPLOYMENT

2007

2016

2008 2009 2010 2011 2012 2013 2014 2015 201695

96

97

98

99

100

101

J

JJ

J

J

JJ

J

J

JJ

J

DE AT NL BE IE FI FR PT IT ES EL EA

0

5

10

15

20

25

30

Hours worked per person

Employment in persons

UNEMPLOYMENT RATE IN SEVERAL EURO AREA COUNTRIES(in % of the labour force, annual averages)

EMPLOYMENT IN THE EURO AREA(indices first quarter of 2008 = 100)

Peak since 2007

source : Ec.


Inthecountriesthatinitiallyhadadeficit,theadjustmentsresulted both from a fall in their domestic demand – and hencetheirimports–andstrongerexportgrowththankstomajoreffortsmade inpastyears to restore theircostcompetitiveness. Some formerly very large current ac‑countdeficitswerethusgraduallyabsorbed,givingwaytoabalancedaccount inGreeceandsurpluses inPortugal,Spain and Ireland. Nevertheless, taking account of theaccumulation of substantial deficits in the past, leadingto increased financial liabilities towards the rest of theworld, the total net international investment positionat mid-2016 was still very negative in Ireland (–190%ofGDP),Greece (–133%ofGDP), Portugal (–106%ofGDP)andtoalesserdegreeSpain(–88%ofGDP).Thosecountries must therefore continue to achieve positive cur‑rent account balances in the future so as to bring their net external liabilities down to more sustainable levels.The environment of modest growth and low inflationmakes it harder to reduce those liabilities, and explainstherelativelystaticoutstandingpositions,despitepositivedevelopmentsintermsofflows.

Theadjustmentonthepartofthedebtorcountrieswasnot accompanied by an adjustment in the opposite di‑rection by the creditor countries. In 2016, large currentaccount surpluses persisted, or even expanded. In the

Netherlands,thesurplushasstabilisedsince 2014–dueto,amongstotherfactors,areductioninitsgasproductssurplus following cuts in domestic output –, but it stillremained substantial at 8.5%ofGDP. InGermany, thesurplus continued to grow, reaching a record 9% ofGDP in 2016.Apartfromoil-balance-relatedeffects, thehigh and persistent surpluses point to excessive savingscompared to investment, accentuated by the continueddeleveraging in those economies. More generally, theincrease in the surpluses is a symptomof thepersistentweaknessofaggregatedemand,reflectedsince2009 ina negative output gap in the euro area in general, andweakpotentialgrowth,inGermanyamongstothers.Thisunder-utilisationofresourcesisafactorintheparticularlylow core inflation, a situationwhich has hampered theeffortsofthedeficitcountries.

In parallelwith themovement in the net external posi‑tion,theprivatesectorcontinuedtoreduceitsdebtlevels,thoughprogresswas slowandpatchy. Thedebt dimin‑ishednotonlyinsomecountrieswherethelevelhadriseninthepre-crisisyears,butalsoinotherswhereitismuchless of a problem.

Inregardtohouseholds,thereductionsinthedebt/GDPratiouptothesecondquarterof 2016werebiggestinthecountrieswiththehighestdebtburdenattheoutbreakofthe sovereigndebt crisis. Thatwasprimarily the case inIreland,where–bymid-2016–thedebtwascutbyalmosthalfinrelationtoitsmaximumlevelthen(over100%ofGDP), but also to a lesser extent in Spain and Portugal(cutbylessthanaquarter)andtoasmallerdegreeintheNetherlands. Some countrieswhere thehouseholddebtratiowasalreadybelowtheaveragealsorecordedaslightfall,e.g.Austria, ItalyandGermany. Inthecaseofnon-financialcorporations,thepicturewasmuchmorevariedin the countries which had the highest (consolidated)debt/GDP ratio in 2012. While all those countries re‑cordedadownwardtrend,someofthemmaintainedthatcorrectionuntil 2016,suchasSpain(tojustoveraquarterof the2012 level)andPortugal (toover10%),while incontrast, others such as Belgium and the Netherlandsreversedthattrendin2013 or 2014.Nevertheless,inthelattercountries,substantialcapitalflowsandintra-grouploanscomeintoplay,duetotheoperatingandfinancingmethodsofthemanymultinationals locatedintheirter‑ritory. Inothercountrieswherethedebtratiowascloseto,orevenbelow,theeuroareaaverage,thechangesincorporatedebtlevelswereminimal.

Despitethisnewreduction,thedebtlevelremainedhighin some cases in 2016.Although it is difficult todefineanequilibriumvalue that thedebt level should tend to‑wards,somecountrieshaveprivatedebtlevelswhichare

CHART 8 THEEUROAREA’SCURRENTACCOUNTSURPLUSONTHEBALANCEOFPAYMENTSHASINCREASED

(in€billion)

2010 2011 2012 2013 2014 2015–300

–200

–100

0

100

200

300

400

500

DE

NL

AT BE FI

FR

IT

ES PT IE

EL

2016

p.m. Euro area

Other euro area countries (1)

source : Ec.(1) Cyprus,Estonia,Latvia,Lithuania,Luxembourg,Malta,SlovakiaandSlovenia.


stillsubstantialfromtheirownhistoricalperspective.Thedownward trend should continue, and could thereforedepresseconomicactivityintheshortterm.Finally,thosecountries sometimes also have a high outstanding public debtwhich,overall,makestheireconomyveryvulnerableto shocks.

Fiscal policy was slightly expansionary

The general government deficit in the euro area as awhole continued to fall, from2.1%ofGDP in 2015 to1.8%ofGDP in 2016. In addition, thepublic debt de‑clinedforthesecondsuccessiveyear,tosettleataround90%ofGDP.Theimprovementinthebudgetbalanceisduemainlytothecontinuingeconomicrecovery,butalsotothelowerinterestchargesandone-offfactors.Evenso,thefiscalpolicystancewasslightlyexpansionary;thatledtoafallinthestructuralprimarysurplus,largelyoffsettingthe said positive factors.

The lower interest charges on the public debt had afavourable impact on public finances in all euro areacountries. The economic climate likewise had a benefi‑cial influence,except inafewsmallMemberStatesandin Belgium. In 2015, Greece, Portugal and Ireland hadconducted one‑off operations for the purpose of bank recapitalisation, thus placing a heavy burden on theirpublicfinances. In 2016, thatceased tohavean impact

on the budget, so that one-off factorsmade a positivecontribution, on average, to the improvement in thebudgetbalance. Judgingby themovement in thestruc‑turalprimarybalance,manyeuroareacountries–includ‑ingSpain,Austria,Italy,BelgiumandGermany–pursuedanexpansionaryfiscalpolicytoalargerorlesserdegree.Thatwas often accompanied by tax cuts. In Spain, de‑spitetheverypositiveinfluenceoftheeconomicclimateandthefallininterestcharges,thestrongfiscalstimulusmeantonlyasmallreductioninthebudgetdeficit,whichstillcameto4.6%ofGDP.InItaly,too,thepublicdeficitcontractedonly slightly,while inAustria andBelgium itactuallygrewbigger.

According to the EC’s autumn forecasts, apart fromSpain,Francealsostillhadabudgetdeficitinexcessofthereferencevalueof3%ofGDP.Thesetwocountries,likeGreeceandPortugal,arestillsubjecttoanexcessivedeficitprocedureunderthecorrectivearmoftheStabilityandGrowthPact(SGP).InNovember 2016,afterhavingexaminedwhetherSpainandPortugalhadtakeneffec‑tive action to complywith the Council’s recommenda‑tions on the subject, the EC felt that the procedureshouldbekeptinabeyanceinthosetwocountries.TheprocedureforFrancewasadjournedinJuly 2015.InthecaseofIreland,CyprusandSlovenia,theexcessivedeficitprocedure was terminated in June 2016. EU MemberStates also have to respect a medium-term objective

CHART 9 DELEVERAGINGCONTINUED,BUTTHEPACEWASSLOWANDUNEVENBETWEENCOUNTRIES

NL FI DE IE AT FR ES BE PT IT EL EA0

20

40

60

80

100

120

140

160

180

200

2016

DE IT EL AT FR ES FI BE PT NL IE EA0

50

100

150

200

250

300

350

400

450

500

Households (2016 Q2)

Non-financial corporations (2016 Q2)

Peak level of total private debt (1)

DEBT OF THE NON-FINANCIAL PRIVATE SECTOR(in % of GDP)

PUBLIC DEBT(in % of GDP)

Peak (2)

Sources:ECB,EC.(1) Since1999 orthefirstavailabledata,dependingonthecountry.(2) Since1999.


under the preventive arm of the sGP. This concerns a referencevalueforthebudgetbalancespecifictoeachcountryandexpressedinstructuralterms.Thebalancesestimated by the EC for 2016 indicate that, in someMember States such as Austria, the structural budgetbalanceisapproachingthemedium-termobjective,andin others such asGermany that goal has already beensurpassed.Conversely,manyeuroareacountries,includ‑ingBelgiumandItaly,stillneedtomakeaconsiderableefforttoattainthatobjective.

The fragility of the euro area’s banking sector is impeding the growth revival

Intheeuroarea,thebankingsectorisanessentialsourceoffundingforprivatesectoractivity.However,thebankswereseriouslyaffectedby thecrisesof2008 and2012.Sincethen,greatprogresshasbeenmadeinstrengthen‑ingtheirbalancesheet,inparticularasregardsreinforcingtheir capital ratios following the comprehensive assess‑ment that preceded the introduction of the single super‑visorymechanism(SSM)inNovember 2014andthephas‑ing in of the new prudential requirements under BaselIII. Increased resilience in termsof solvencyand liquidityand an accommodativemonetary policy havehelped to

restorethebankcreditchannel.Withtheadditionalsup‑portofthedemandrevival,thegrowthofbanklendingtotheprivatesectortookoffagainrecently,butremainsveryfragileinsomecountries.Yetcapitalisationlevelsstillvarywidely betweenMember States,with the lowest Tier 1capital ratios in mid-2016 being recorded in Portugal,Italy,LatviaandSpain.

The problems still confronting the banking sector caused episodesofnervousnesson thefinancialmarketsat theendof 2015andduring 2016.Thechallengesessentiallyconcern theweakoutlook for the returnoncapitalandthe persistence of large outstanding amounts of non‑performingloansinsomecountries,alegacyofthecrisiswhichcontinuestoencumberbanks’balancesheetsandcouldfurtherimpairtheirprofitability.

While the low level of interest rates attenuated thecyclical slowdown and supported economic activity,it tended to be detrimental to the profitability of thefinancial sector. In such an environment, the accumu‑lated assets could only generate ameagre return, andthatwas sometimes combinedwith the persistence ofoperationalandstrategicmodelswhichwereoutdated,inappropriateorcostly.Thismodestprofitabilitywhich,

CHART 10 THEFURTHERREDUCTIONOFGOVERNMENTBUDGETDEFICITSISACCOMPANIEDBYASLIGHTEASINGOFFISCALPOLICY

EL PT NL IE ES FI IT FR DE ATBE EA

–2

–1

0

1

2

3

4

5

6

DE NL IE AT FI IT EL PT BE FR ES EA–5

–4

–3

–2

–1

0

1

Structural primary balance

Cyclical component

Interest charges

One-off factors

Budget balance

BUDGET BALANCES IN 2016(in % of GDP)

COMPONENTS OF THE BUDGET BALANCES(change in 2016 compared to 2015, percentage points of GDP)

source : Ec.


inmid-2016,was lowest inGreece,Portugal,GermanyandItaly,hadanimpactonthevaluationofthebanks’capital,affectingtheirabilitytoraisenewfundsonthecapitalmarkets;ultimately,thatthreatenedtolimittheirscopeforlendingtotheprivatesectorortoimplyasub-optimum allocation of the capital.

Inadditiontotheseissues,thereareproblemsconcerningassetqualityandcreditrisk.Thebalancesheetsofsomebanks still often have massive outstanding amounts of non‑performing loans as a result of past crises. ParticularlyhighratioswereseeninCyprusandGreeceand to a lesser degree in Italy, Ireland and Portugal.In some of those countries, the substantial volume ofnon-performingloanswascombinedwithrelativelylowcapital ratios. A problematic level of private sector debt can cause additional vulnerabilities, owing to the pos‑sibleriskofdefaultthathastobeadequatelycoveredbyprovisions. Although bank balance sheets are still being cleaned up, various factors prevent that type of loanfrombeingliquidatedmorequicklyandefficiently,suchas bankruptcy legislation and procedures, or practicesconcerning loan loss provisions which vary greatly be‑tweenMemberStates.Anin-depthexaminationofthisissueandtheinitiativestakenrecentlytoresolveitisde‑scribedindetailinthepartofthisReporton“Prudentialregulationandsupervision”.Finally,sincebanksinmanycountries still have a very substantial exposure to debtinstruments issued by national governments, renewedpoliticalturmoilcouldfurtherexacerbatethesaidweak‑nesses in the banking sector.

On the road to completion of Economic and Monetary Union

Despite the progress achieved since the sovereign debt crisis in the euro area – particularly the establishmentof the banking union and the improvement in eco‑nomicgovernance– theEconomicandMonetaryUnion(EMU) isstill imperfect.ThatpromptedthePresidentsofthe European Commission, the European Council, theEurogroup,theEuropeanCentralBankandtheEuropeanParliament topublish a report in June 2015 settingouttheir plans for strengthening EMu. The intention is to finaliseEMUbynolaterthan2025.InOctober 2015,inaccordancewiththatreport,theEChadalreadyapprovedaninitialsetofmeasuresandmaderecommendations.InSeptember 2016,inlinewiththatpackageofmeasures,theEcofinCouncilcalledontheeuroareacountriestosetupnationalproductivityboards.Thoseboardsaretoex‑aminedevelopmentsinproductivityandcompetitiveness,and conduct an independent analysis of the challengesthattheypresentforpolicy.TheMemberStatesandtheECcanusethatindependentexpertiseintheannualmon‑itoringofeconomicpolicyinthecontextoftheEuropeanSemester.Asregardsfiscalpolicy,atitsDecembermeet‑ing, theEcofinCouncildecidedtogiveagreaterroletotheexpenditureruleindeterminingandassessingtheSGPobjectives.Nevertheless,thestructuralbudgetbalancere‑mainsanessentialelementofthebudgetaryframework.Also,attheNovember 2016launchoftheannualcycleoftheEuropeanSemesterofeconomicpolicycoordination,theECadvocatedafiscalpolicystanceaimedmoreatsup‑portingtherecoveryoftheeuroareaasawhole. Inad‑dition,inOctober 2016,theECappointedtheChairmanand the four members of the European fiscal Board set upinOctober 2015.

During the year under review, thanks to the progressachieved, thefinancial union –oneof the cornerstonesof the Five Presidents’ Report –was consolidated as re‑gardstheEuropeanCapitalMarketsUnion(CMU).Sincethe 2015 action plan,which defined the prioritymeas‑urestoenabletheCMUtotakeeffectby 2019,thefirstfollow-upreportwasproducedinApril 2016.Tofacilitatethe development of new types of funding, the EC alsoproposedrenewingthelegislativeframeworkconcerningventurecapitalbyamending, inJuly,theRegulationsonEuropean venture capital funds (EuVECA) andEuropeansocialentrepreneurshipfunds(EuSEF),bothofwhichaimto support young, innovative businesses and firms thatwishtomakeapositivesocialimpact.ThosechangeswereendorsedbytheCouncilattheendoftheyear. Inaddi‑tion,thesecuritisationmarketwillbestrengthenedbytheproposal submitted in September 2015 for establishinganewregulatoryframeworkforsimple,transparentand

CHART 11 FRAGILITIESPERSISTINTHEEUROAREA’SBANKINGSECTOR

(non-performingloans,in%oftotalloansandadvances(1))

CY EL IT IE PT MT SI ES LT SK FR LV BE AT NL DE EE LU0

10

20

30

40

50

2016 Q2 (or latest available data)

Euro area

Source:IMF.(1) NodataavailableforFinland.Comparabilityofthedataacrosscountriesmaybe

limitedduetotheuseofdifferentdefinitionsandconsolidationperimetersfornon‑performing loans in domestic banking sectors.


standardised(STS)securitisationoperations(SecuritisationRegulation). Finally, in November 2016, in order to re‑movenationalbarrierstocapitalmarket integration,theEc tabled a proposal on business restructuring and in‑solvencywiththeaimofspeedingupassetrecoveryandoffering a second chance to entrepreneurs suffering their firstbankruptcy.

1.3 TheEurosystem’slowinterestratepolicyisintendedtosupporttherecoveryintheeuroarea

Increased risks to price stability required supplementary measures

Inrecentyears,theECBGoverningCouncilhasadoptedawiderangeofstimulusmeasures.Thattookplaceagainstthe backdrop of persistently low inflation in the euroarea:sincemid-2013, inflationhasbeen lowerthanthelevelcompatiblewithpricestability,i.e.aratebelow,butcloseto,2%.Moreover,theeconomicrecoveryremainedweak: after eight years, thegap in relation topotentialoutputhasstillnotbeenclosed,sothatunderusedpro‑ductioncapacityisexertingdownwardpressureonprices.

The Governing Council began by further reducing thekey interest rates, and in June 2014 the deposit facilityrate was cut below zero for the first time. In view ofthe lack of scope for reducing short‑term interest rates anyfurther, itthenextendeditsrangeof instrumentstocontinue steering the economy’s financing conditions.One of those exceptional but crucialmeasureswas theJanuary 2015decisiontolaunchanexpandedassetpur‑chaseprogramme(APP).Thatmeasuresupplementedtheexisting programmes for the purchase of covered bankbonds and asset-backed securities by adding a massiveprogramme for purchases of government bonds. The APP wasoriginallyintendedtorununtilSeptember 2016,butitwasemphasised that itwould certainly continueuntiltheGoverningCouncilsawasustainedadjustmentintheinflationpathconsistentwith itspricestabilityobjective.The Governing council thus added a further dimension to theforwardguidancewhich ithadadopted inthesum‑merof2013. lnfact, it indicatedthat itwouldcontinuetopursueanexpansionarymonetarypolicyuntilitspricestabilitymandatewasfulfilled.

However, unexpected financial and economic eventsexerting downward pressure on economic activity andinflationnecessitatedfurthermonetaryeasingandhenceadjustmentoftheAPP.InDecember 2015,theGoverningCouncilthusdecided,inthelightofthedownwardrevi‑sionoftheinflationforecast,tocutthedepositfacilityrate

from–0.20 to–0.30%andtoextendtheplannedperiodforassetpurchasesfromtheendofSeptember 2016tothe end ofMarch 2017, or even longer if necessary. Itlikewise decided to extend the list of assets eligible fortheAPPtoincludesecuritiesissuedbyregionalandlocalgovernments in theeuroarea, and to reinvest theprin‑cipalrepaidonmaturingbondsforaslongasnecessary.Finally, the Governing Council also stressed that it wasreadytotakeadditionalmeasuresinthefuture.Insodo‑ing, itemphasised that theAPPwasflexible so that thesize,compositionanddurationof theprogrammecouldbemodified.

InMarch 2016,theGoverningCouncilonceagaindem‑onstrateditswillingnesstoact.Atthebeginningofthatyeartheoutlookforworldgrowthdeteriorated,financialmarketvolatility increasedand inflationexpectationsbe‑ganfallingagain.TheinflationforecastsproducedbytheEurosystem’sstaffpointedtoheightenedriskstopricesta‑bility;theMarch 2016projectionsassumedinflationratesofonly0.1%and1.3% in 2016and 2017 respectively(inDecember 2015therespectiveforecastrateswerestill1%and1.6%),whereasfor 2018theyforesawinflationat1.6%,a levelwhich isadmittedlybelow,butstillnotcloseto,2%.

CHART 12 THERENEWEDFALLININFLATIONEXPECTATIONSATTHEBEGINNINGOF 2016REQUIREDMONETARYEASING

H

H

H HH H

H

H

H

HH

HH

H

HH

H

HHH

H

2012 2013 2014 2015 2016

Derived from financial data (1)

(left-hand scale)

0.8

1.3

1.8

2.3

2.8

1.6

1.7

1.8

1.9

2.0

Based on survey data (2)

(right-hand scale)

March meeting of the Governing Council

LONG-TERM INFLATION EXPECTATIONS(in %)

Sources:ECB,Bloomberg.(1) Implicitinflationratederivedfromswapscoveringtheinflationriskinthe

euroareaforafive-yearperiodcommencingfiveyearsafterconclusionofthecontract.

(2) Averageoftheaggregateprobabilitydistributionofinflationexpectationsinfiveyears.DataobtainedfromtheECB’squarterlysurveyofprofessionalforecasters.


Atitsmeetingon10 March 2016,theGoverningCounciltherefore announced a comprehensive package of newmeasures. As regards the APP, the monthly asset pur‑chaseswere increased from €60 billion to €80 billion.In addition, itwas decided that from June 2016 bondsissued by non-financial corporations(1) would also bepurchased under the APP (corporate sector purchase programme – CSPP). Moreover, the Governing Councildecided to make further cuts to its key interest rates:the rates on themarginal lending facility and themainrefinancing operations were reduced by 5 basis points,to0.25%and0%respectively,whilethedepositfacilityratewascutby10 basispoints to–0.40%. Inaddition,the Governing council announced that it intended to holdthekeyinterestratesatorbelowtheirpresentlevelsforanextendedperiodoftime,wellpastthehorizonforthe net asset purchases,which it had confirmedwouldcontinueuntilMarch 2017orbeyond,ifnecessary.Finally,inMarch 2016, itwas alsodecided to launch a secondseriesoffourtargetedlonger-termrefinancingoperations(TLTROII),withatermoffouryearsandafixed interest

rate. Those operations provide cheap and stable funding for the banks in return for more lending to the private sector.Byanchoringtheinterestrateontheselong-termoperations,theGoverningCouncilalsoindicatesthatthekey interest rateswill remain low for a long time, thusfurtherreinforcingitsforwardguidance.

All these measures are designed to hold down all theinterestratesthatarerelevantintheeconomy.Themorefavourableborrowingconditionsaremeanttoencouragehouseholds,businessesandpublicauthoritiestoconsumeandinvest,soastotakefulladvantageoftheeconomy’sproductionpotentialanddriveupinflation.

Practical implementation of the monetary policy measures

At theendof 2016, the securitiespurchasedunder theAPPamountedtoaround€1500 billion,accountingforapproximately 40% of the Eurosystem’s balance sheettotal.Governmentbondsmadeupthebulkofthat,with€1259 billion.Thebalancesheetalsocontainedcoveredbank bonds amounting to €204 billion, bonds issuedby non-financial corporations totalling €51 billion, and

(1) Morespecifically,thisconcernshigh-quality(investment-grade)euro-denominatedbondsissuedbynon-bankbusinessesestablishedintheeuroarea.

CHART 13 WITHTHEKEYINTERESTRATESCLOSETOTHEFLOOR,THEEUROSYSTEM’SBALANCESHEETMEASURESAREVERYIMPORTANTFORPROVIDINGAMONETARYSTIMULUS

20121 500

1 750

2 000

2 250

2 500

2 750

3 000

3 250

3 500

3 750

2013 2014 201520162012 2013 2014 2015 2016

EUROSYSTEM CONSOLIDATED BALANCE SHEET(in € billion, assets)

–0.5

0.0

0.5

1.0

1.5

2.0

KEY INTEREST RATES AND OVERNIGHT MONEY MARKET RATES(in %)

Deposit facility rate

Marginal lending facility rate

Main refinancing rate

Eonia rate

Other balance sheet items

Covered bank bonds

Asset-backed securities

Government bonds

TLTRO

APP

Bonds issued by non-financial corporations

Sources:ECB,ThomsonReutersDatastream.


asset-backedsecuritiesamountingto€23 billion.Thetar‑getpurchasevolumesweremet,whiletheAPP’sflexibilitylimitedthepotentialmarketdisruptionthatcouldresult,forexample,fromashortageofsecureassetsonthepri‑vatemarket.Thus,duringthesummer,takingaccountoftheseasonalreductioninfinancialmarketliquidity,small‑ervolumeswerepurchased,andthatwasoffsetinothermonths.MostoftheEurosystemcentralbanksalsomadearrangements for lending securities,whereby the assetsheldundertheAPP–particularlygovernmentbonds–areloaned to market participants. Those securities are in fact highlyprized,partlybecausetheyconstitutecollateralforrepo transactions.

As regards the TLTRO II, demand for liquidity at thetime of the three operations in June, September andDecembertotalled€399 billion,€45 billionand€62 bil‑lionrespectively.However,thenetliquidityinjectedintothebankingsystem(€115 billion)waslessthanthesumofthoseamounts.Infact,atthetimeofthethreeopera‑tions,butmainlythefirstone,thebanksrepaidpartoftheTLTROIfundsandborrowedthemoneybackintheformof TLTRO II funds. Three characteristicsmake thelatterfinanciallymoreattractive.First,theyarecheaper:under the TLTROs, the banks pay a fixed interest ratecorresponding to the rateon themain refinancingop‑erationsprevailingatthetimeoftheoperation.Inviewof thecut in thekey interest rates inMarch 2016, thenewTLTROsarethereforecheaperthanthoseconcludedduring thefirst seriesofoperations.What ismore, thecostoffinancing theTLTRO II could fallex post to the levelofthedepositfacilityrate,providedthatthebanksgrant sufficient credit to theprivate sector(1).Next, theTLTROIIoffersamorestablesourceoffunding:incon‑trast towhathappenedwith thefirst series, thebanksare not obliged to effect early repayment of the totalamountborrowediftheygrantinsufficientcredit.Finally,the longer term of the TLTRO II alsomakes the seriesmoreattractivethantheTLTROIforwhichtheduedate(September 2018)isapproaching.

InfluencedbytheAPPandtheTLTROs,theconsolidatedbalance sheet of the Eurosystem continued to expand,exceeding its mid-2012 peak. In accordance with thegrowthof thecentralbank’sbalancesheet, the liquiditythateuroareacreditinstitutionsholdwiththeEurosystemalsoincreases.Thus,attheendof 2016,theexcessliquid‑ity–i.e.thereservesthatcreditinstitutionsholdwiththecentral bank over and above their reserve requirement,eitherontheircurrentaccountorviathedepositfacility–cametoaround€1200 billion,comparedto€655 billion

at thebeginningof the year. Sincebanks endeavour toplace theirexcess reservesonthemarket, theabundantsurplus liquidity stabilised the overnight money marketrate– theEonia–ata level close to thedeposit facilityrate.Throughout 2016,theovernightmoneymarketratethereforeremainednegative,sothatinterbankfinancingcostswereatunprecedentedlylowlevels.

The measures produced results : lower nominal interest rates and improved bank lending

Themonetarypolicymeasuresresultedinsignificanteas‑ing on many financial market segments. Thus, the for‑wardguidanceandthesignalgivenbytheAPPregardingthemonetarypolicy stance–namely that thekey inter‑est rateswill remain low for an extended period – alsobrought about a further fall in the longer‑term risk‑free interestrates,leadingtoflatteningoftheyieldcurve.

Similarly, interest rates on government securities fellfurther in most euro area countries in 2016, decliningtoall-time lows. Itwas the longest-dated securities thatrecorded the largest falls. Apart from the higher demand resultingfromthepurchasesundertheAPP,otherfactorsalsodrovedownyieldsongovernmentbonds,particularlythose of the strongest sovereign issuers. The nervous‑nesson thefinancialmarkets, triggeredpartlybyBrexit,andtheneedtoprovidegood-qualitycollateral for repotransactionsboosteddemand for this typeof securities,andparticularlyGermangovernmentbonds.Therelativelylimited outstanding volume of government securities is‑sued by some largeMember States combinedwith thecharacteristicsoftheAPP,whichdistributesthepurchasesof government bonds among the euro area countries according to the ECB’s capital key, also led to a biggerdecline in interest rates on certain government bonds. As the capital key reflects the size of a country’s economyandpopulation,aconsiderableproportionofthepurchas‑es concerned the German Bund in particular. However,the outstanding amount of German government bonds andtheprospectsforissuanceofthosesecuritiesarefairlylimited,sotheAPPexertsevenstrongerdownwardpres‑sure on the interest rates on German securities than on thoseofcountrieswitharelativelylargeoutstandingvol‑umeofgovernmentpaper,butwitharathersmallshareinthepurchasesundertheAPP(seealsobox1).Finally,theEurosystem’soriginaldecisionnottopurchasesecuri‑tiesundertheAPPofferinganinterestratelowerthanthedeposit facility rate also reduced the range of securitiesactuallyeligiblefortheAPP.ThatcertainlyappliestotheGerman Bund, as the short- and medium-term interestratesonthosebondsweregenerallybelowthatthresholdin 2016.Tomeetitstargetforpurchases,theEurosystemtherefore bought government securities with longer

(1) FormoreinformationonTLTROII,seehttps://www.ecb.europa.eu/press/pr/date/2016/html/pr160310_1.en.html.


maturities. Consequently, the longer-term interest ratesofstrongeuroareacountriesalsodeclined,approachingthe deposit facility rate, or even falling below it,whichsometimespresentedchallengesfortheEurosystem’sim‑plementationofthe APP.

Although these factors mainly drove down the bondyieldsof strong issuers, the spreadson thegovernmentbondsofmosteuroareacountriesinrelationtotheBund,forexample,werefairlystableafternarrowingsharplypri‑ortotheprogramme’slaunchandatitsstart.Thatcouldindicate the active operation of the portfolio rebalancing channeloftheAPP:byrearrangingtheirportfolioofeuroarea government bonds to the detriment of securities pur‑chasedona largescalebytheEurosystembut infavourofthoseofferinghigheryields,investorsalsodrovedowninterest rates on the latter securities.

Apart from thebanks andpublic authorities, businessesalso benefited from the lower financing costs. TheAPPpurchasesofbonds issuedbynon-financial corporationsled to a considerable decline in the interest rates on those securities. Yields on bonds issued by both financial andnon-financialcorporationsnoteligibleforpurchaseunderthe CSPP also declined, once again indicating portfoliorebalancing in thewake of the APP. At the end of theyear,while those interest ratesbegan to creepupwardsagaintheyremainedbelowthelevelprevailingatthebe‑ginningoftheyear.Itispossiblethatthemorefavourablefinancingconditions in 2016encouragedthefundingofbusinessesviathemarket,astherewasinfactanincreasein net issuance of private sector bonds.

Thebankingsector–whichperformsakeyroleinmon‑etary transmission within the euro area – continued topassonthemonetarypolicystimulustotherealeconomy.The monetary policy measures thus further supportedlending to the private sector. On the one hand, bankfunding costs for households and businesses continued to fall. Debit interest rates on bank loans to businesses in the various euro area countries therefore converged again tosomeextent,reflectingafurtherreductioninfinancialfragmentation.Also,thepositivedynamicsofthevolumeofbanklendingtotheprivatesectorpersisted,butinthevulnerableMemberStatesotherthanItaly,thegrowthofcredit remained negative.

Thebanklendingsurvey(BLS)revealsthatboththecreditsupplyanddemandforcreditcontributedtothestrongercreditexpansionintheeuroarea.Loancriteriaforbusiness‑esandhouseholdswereeased,usuallyasaresultofkeenercompetitionandattenuationofthebanks’riskperception.ThebanksalsoannouncedthattheliquiditygeneratedbytheAPPwouldbeusedinthefirstinstancetoexpandtheir

CHART 14 NOMINALINTERESTRATESFELLSHARPLY

(in%)

–1

0

1

2

3

4

201620152014

–1

0

1

2

3

4

201620152014

–0.6

–0.3

0.0

0.3

0.6

0.9

1.2

YIELD ON GOVERNMENT BONDS

YIELDS ON EURO-DENOMINATED PRIVATE SECTOR BONDS

RISK-FREE YIELD CURVE(OIS ; average over the period)

(1)

2015

January 2016

2014 March 2016

October 2016

Deposit facility rate (level since March 2016)

December 2016

7-year German bonds2-year Spanish bonds2-year German bonds

7-year Spanish bondsDeposit facility rate

Financial corporations BBB

Non-financial corporations AAA

Financial corporations AAA

Non-financial corporations BBB

Deposit facility rate

1y 2y 3y 4y 5y 6y 7y 8y 9y 10y

Sources:BarclaysCapital,ThomsonReutersDatastream.(1) InterestratesonEoniaswapswithdifferentmaturities.


lending.Inaddition,theyindicatedthatthenegativeinter‑estrateonthedepositfacilityhadapositiveinfluenceonthecreditvolume,althoughitcouldatthesametimeputpressure on their interestmargin. That said, demand forloans on the part of businesses and households also con‑tinuedtoriseasaresultofthelowinterestrates,mergersandacquisitions,arevivalinconsumerconfidence,aswellas the improved outlook on the housing market.

The recovery of credit growth and the implementationof the APP – so long as the asset seller is a non‑bank resident of the euro area (1)–engenderedastrongexpan‑sionofthemoneysupply.ThebroadmonetaryaggregateM3 recordedrelativelystableyear-on-yeargrowthof5%

throughout 2016.Thedrivingforceherewastheexpan‑sion of themost liquid components ofM3, particularlysightdeposits (M1).The lowandflatprofileoftheyieldcurveinfactimpliesthattheopportunitycostsofholdingthemostliquidM3 assetsareminimal.

The favourable funding conditions in turn help to restore economic activity, inflation and inflation expectations.As a result, the monetary policy measures slowed thedownwardtrendininflationexpectationsandsupporteddomestic demand in the euro area.

CHART 15 BANKFINANCINGOFTHEPRIVATESECTORINTHEEUROAREACONTINUESTOIMPROVE(1)

2012 2013 2014 2015 2016–6

–4

–2

0

2

4

6

2012 2013 2014 2015 2016

BANK LOANS (2) TO THE NON-FINANCIAL PRIVATE SECTOR

AND M3(year-on-year percentage change)

1.5

2.0

2.5

3.0

3.5

4.0

4.5

DEBIT INTEREST RATES ON BANK LOANS TO HOUSEHOLDS (dotted line) AND NON-FINANCIAL CORPORATIONS (solid line) (in %)

M3Euro area Vulnerable countries Other countries

source : EcB.(1) ThevulnerablecountriesareCyprus,Spain,Greece,Ireland,ItalyandPortugal.TheothercountriesaretheremainingeuroareaMemberStates.Thetwoseriesofdata

concernaGDP-weightedaverage.(2) Takingallmaturitiestogether.Thedataareadjustedforsecuritisation.

Box1 –AssetpurchaseprogrammesintheUnitedStatesandintheeuroarea:impactongovernmentpaperheldbytheprivatesector

Centralbankassetpurchaseprogrammescandepresslong-terminterestratesviavariouschannels.Forinstance,bypurchasingcertain long-termsecuritiesona substantial scale, thecentralbank reduces the supplyof thosesecuritiesontheprivatemarketsothattheirpricerisesandtheiryielddeclines.Certaininvestorsprefertoholdthesesecuritiesandarethereforepreparedtopayahigherpricetoacquirethese“scarce”assets.Inaddition,thecentralbankcanreducetheaggregatelevelofthedurationrisk(i.e.theexposuretounexpectedchangesinthekeyinterestrate)intheprivatesectorportfoliobytakinglong-term–andhenceriskier–securitiesoffthemarket,

4

(1) Formoreinformation,seebox2intheReport2015.


4

replacing themwith safe, short-termsecurities (centralbank reserves).As the totalduration risk in themarketdiminishes, private investors should demand less compensation for that risk, thus lowering the termpremiumincluded in the return on long‑term securities.

Ofcourse,purchasesby thecentralbankarenot theonly factoraffecting thesupplyofsecuritiesavailableontheprivatemarket:debtsecurityissuersalsoplayanimportantrole.Ascentralbankpurchasesareconcentratedmainlyongovernmentpaper–onwhichtheyieldisanimportantbenchmarkforfixingthepriceofawiderangeoffinancialassets–theyindicateasubtleinteractionbetweenmonetaryandfiscalpolicy.Whilethecentralbanktendstoputdownwardpressureonlonger-termsovereignbondyieldsviaitspurchasepolicy,governmentscanpartlyoffsetthateffectbyissuingmoreofthosedebtsecurities,e.g.forthespecificpurposeoftakingadvantageofthelowinterestrates.ThisboxaimstoexaminetheextenttowhichmonetaryandfiscalpolicyhavechangedtheavailabilityofgovernmentpaperontheprivatemarketintheUnitedStatesandintheeuroarea.

Between December 2008 and October 2014, the Federal Reserve launched three programmes of large-scaleassetpurchases (LSAPs)(1) and thus removed from the private market long‑term debt securities totalling around $3900 billion. The purchases comprised US government bonds and debt securities issued or guaranteed bygovernment-sponsoredenterprises(GSEs).Thus,attheendof 2014,theFed’sportfolioofsecuritieshadexpandedby22%ofGDPcomparedtothethirdquarterof2008,whennopurchaseprogrammeshadyetbeenintroduced.Over the same period, the US Treasury issued additional sovereign bonds for the equivalent of around 50%ofGDP,whilethenet issuanceofsecuritiesbytheGSEsremainedratherflat.DespitetheLSAPs, thesupplyofsovereigninstrumentsontheprivatemarketthereforeincreasedconsiderablyinnetterms.Theadditionalissuanceof sovereign securities thusoffset thedownward effect ofmonetarypolicyon interest rates; from the central

HOLDERSOFGOVERNMENTPAPER(1)

(changesinoutstandingamounts,in%ofGDPin2014,comparedtothequarterprecedingtheannouncementofthefirstpurchaseprogramme)

0

10

20

30

40

50

–12–9–6–30369

12

–12–9–6–30369

12

–12–9–6–30369

12

LSAP1 LSAP2 LSAP3 PSPP PSPP PSPP

2008

Q3

2009

Q3

2010

Q3

2011

Q3

2012

Q3

2013

Q3

2014

Q3

UNITED STATES

2014

Q4

2015

Q1

2015

Q2

2015

Q3

2015

Q4

2016

Q1

2016

Q2

2016

Q3

EURO AREA20

14 Q

4

2015

Q1

2015

Q2

2015

Q3

2015

Q4

2016

Q1

2016

Q2

2016

Q3

2014

Q4

2015

Q1

2015

Q2

2015

Q3

2015

Q4

2016

Q1

2016

Q2

2016

Q3

GERMANY BELGIUM

Public debt purchased by the central bank for monetary policy purposes (b)

Public debt held by the private sector (a – b)

Outstanding public debt (a)

Sources:ECB,BureauofEconomicAnalysis,EC,FederalReserve.(1) Theconceptof“publicdebt”usedinthechartvariesslightlybetweentheUnitedStatesandtheeuroarea.FortheUnitedStates,itcoversdebtsecuritiesissued

bothbytheAmericangovernmentandbytheGSEs.ThesetwoassetcategoriescanbeconsideredclosesubstitutesandwerepurchasedinmoreorlessequalproportionsbytheFederalReserveundertheLSAPs.Intheeuroarea,theoutstandingamountofthe“publicdebt”onlycomprisessecuritiesissuedbynationalgovernments;consequently,thepurchasesbytheEurosystem,representedbytheredlineinthechart,alsoconcernonlythetypeofsecuritiespurchasedunderthePSPP(inotherwords,excludingsecuritiesissuedbysupranationalinstitutions).Thepublicdebtconceptusedinthechartconcernsgovernmentpaperatmarketprices:consequently,itdiffersfromtheMaastrichtTreatydefinitionofthepublicdebt,whichrelatestotheconsolidatedtotalpublicdebtatnominalvalue.Themovementsshownonthechartthereforedonotnecessarilycorrespondtothoseconcerningtheusualconceptsofpublicdebt.

(1) LSAP1 ranfromNovember2008 totheendofMarch2010.LSAP2 –whichwasconfinedtopurchasesofUSgovernmentbonds–ranfromNovember2010 toJune 2011,andLSAP3 ranfromSeptember2012 totheendofOctober 2014.


bank’spointofview,thatisnotnecessarilynegative,asthefiscalstimulusprovidesadditionalsupportfordomesticdemand,whichmaybeusefulwhenthemonetarypolicyinstrumentscomeupagainstlimits,e.g.whenshort-termnominal interest ratesareat their lowerbound.Moreover,a steeperyieldcurve implies lower risks tofinancialstability,andreducesthetransformationriskfacingthecentralbank’sbalancesheetviapurchasesoflong-termsecuritiesfinancedbymeansofshort-termliabilities.

Intheeuroarea,thesituationisdifferent.Inviewofthecurrentratherneutralfiscalstance,relativelyfewsovereignbondsareissued.Theadditionalgovernmentpaperissuedsincetheendof 2014(totallingaround6%ofGDP)wasentirelyabsorbedby thepublic sectorpurchaseprogramme (PSPP), so that the supplyof sovereignbondsfortheprivatesectorremainedvirtuallyunchanged.Theeuroarea’sfiscalpolicy,unlikethatintheUnitedStates,thereforedidnotoffsetthepressureexertedbythecentralbankonlonger-terminterestrates.

However,theimpactofthePSPPonyieldsongovernmentsecuritiesvariesfromoneeuroareacountrytoanother,dependingon the issuance of newdebt. InGermany, the virtual absence of any net issuance of governmentpapercombinedwiththepurchasesunderthePSPPsignificantlyreducedtheavailabilityofthoseinstrumentsontheprivatemarkettobelowtheend-2014level.Drivenbyaflighttosafety,yieldsonGermangovernmentpaperslumpedtoanall-timelow,andactuallybecamenegativeuptoamaturityof13 yearsinthesummerof 2016.InBelgium,theissuanceofgovernmentpaperasapercentageofGDPwasinlinewiththatintheeuroareain 2015,butitincreasedsubstantiallyin 2016.Consequently,thevolumeavailablefortheprivatemarketrecentlyexceededtheend-2014level.

InparallelwiththeimplementationofthePSPP,thebanksreducedtheirexposuretothepublicsector.Inthefinalquarterof 2014,theeuroareabanksstillheld,onaverage,€1826 billionineuroareagovernmentbonds,butbyNovember 2016thatvolumehaddroppedbyalmost10%,anditsshareinthebalancesheettotalwasdownfrom6%to5.5%.Theaccumulationofeuroareagovernmentbondsontheassetssideofthebanks’balancesheetsthereforeseemstobeending.Itisworthnotingthatthisgradualreductionisduemoretoashrinkingportfolio

EUROAREASOVEREIGNBONDSHELDBYBANKS(1) FROM THE EURO AREA (2)

(in€billion)

2006 2008 2010 2012 2014 20160

300

600

900

1 200

1 500

Domestic government bonds

Bonds issued by governments of other Member States

Launch of the PSPP

source : EcB.(1) ThisspecificallyconcernsmonetaryfinancialinstitutionsexceptfortheEurosystem.(2) Toavoiddistortionofthemovementintheoutstandingamountsofsecuritiesbythereclassificationorrevaluationofsecurities,theoutstandingamountforJanuary

2005 wasincreasedcumulativelybythemonthlyvolumeoftransactionsinsuchsecurities.

4


There are limits to the reduction of the key interest rates

The transmission of the low interest rate policy tocredit interest rates and hence to the real economy

continuedin 2016,butinthefutureitcouldbeham‑pered by the downward rigidity of interest rates onbankdeposits.Althoughthebanksdidtosomeextentpass on the reduction in the deposit facility rate intheirratesoncustomerdeposits,theformerstoodat

ofbondsissuedbytheirowngovernment,whiletheportfolioofbondsofothergovernmentsintheeuroareaismorestable.Asthesovereigndebtcrisisintheeuroarearevealedtherisksinherentincloselinksbetweennationalgovernmentsandthedomesticbankingsector,theEurosystem’spurchaseprogrammeisthusindirectlyhelpingtosupportfinancialstability.Asmallerconcentrationofsovereignbonds–andinparticularthoseofthedomesticmarket–onthebanks’balancesheetsisinfactagoodthinginthatrespect.

CHART 16 LIMITSTOFURTHERCUTSINTHEKEYINTERESTRATES

–1 0 1 2 3 4 5 6

L

L

L

L

L

L

L

L

L L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L

L 0

10

20

30

40

50

60

70

80

90

100

Sept. 2016

June 2016

Jan. 2016

March 2015

June 2014

Dec. 2013

Sept. 2012

May 2010

Jan. 2008

DISTRIBUTION OF THE INTEREST RATES OFFERED BY A SAMPLE OF 283 EURO AREA BANKS ON HOUSEHOLD AND BUSINESS DEPOSITS

(1)

(in %)

Households Non-financial corporations

COMPOSITION OF THE BALANCE SHEET OF EURO AREA BANKS(in % of the balance sheet total, liabilities)

September 2016

Relatively fixed costs

Capital and reserves

Other deposits

Securities issued : long-term and fixed interest rates

Securities issued : short-term or variable interest rates

Interbank deposits

Eurosystem financing

Other liabilities

source : EcB.(1) Therectanglecontainsthevaluesbetweenthelowerandupperquartiles.Thehorizontallinesincludethevaluesbetweenthelowerquartileless1.5 timestheinterquartile

rangeandtheupperquartileplus1.5 timestheinterquartilerange.Thedotsindicatetheextremevalues.


at –0.40% at the end of 2016while the latterwasbarelynegative.

One reason for thedownward rigidityofdeposit interestrates is that retail customers’ deposits are an important,stable,andthereforevaluablesourceoffundingforbanks.However,iftheremunerationondepositsweretobecomelowerthanthecostofholdingbanknotes,householdsandbusinessesmightdecidetowithdrawtheirdepositedfundsandholdbanknotes instead.As large-scaledepositwith‑drawalscouldcausemajorproblemsforthebankingsector,banksarereluctanttocutthedepositratesbelowzero.Inviewofthesubstantialliquidassetsofsomefirms,thecostofholdingtheseassetsinbanknotesissignificant,sothattheinterestrateontheirbankdepositscanbecomeslightlynegative, and that did happen recently at some banks.Furthermore,somecountriessetlegallimitsonthereduc‑tionofcertain interest rates.That is thecase inBelgium,forexample,wheretheinterestrateonregulatedsavingsdepositscannotbelessthan0.11%(0.01%forthebasicrateand0.10%fortheloyaltybonus).

Thedifficultyofcuttingtheremunerationondepositsbelowzero,combinedwiththeimportanceofdepositsasasourceof funding, implies that – despite the low policy interestrates–thebanksfacerelativelyhighandrigidfundingcosts.Whendepositinterestratesdroptotheirlowerbound,banksmaydecidenottoreducetheircreditinterestratesanyfur‑ther,thuspreservingtheirinterestmargin.Furthercutsinthecentralbank’spolicyinterestrateswillthusceasetoinfluencecreditrates,andthatwillseriouslyimpedethetransmissionoftheaccommodativemonetarypolicythroughthebankingsector. The excess capacity in some national banking sys‑temsandtheresultingfiercecompetitionmayneverthelesspromptbankstocontinuereducingtheircreditinterestrates,eveniftheyleavetheirdepositratesunchanged.Moreover,the large proportion of loans granted at a variable interest rate–whichautomaticallytrackstheEuribororothershort-term interest rates – undermines the interest income of some banks.Cutsinthepolicyinterestratecanthusleadtolowercreditinterestrates,butatthesametimetheydepressthebanking sector’s profitability which has been under stresssince the outbreak of the crisis. In the long run, that cancauseacontractionofthecreditsupply,thwartingmonetarytransmission.Awareofthelimitsoftheinterestrateinstru‑ment,theECBGoverningCouncilthereforeindicatedthatitcannotcontinueindefinitelycuttingtheshort-termnominalinterestratesbelowzero.

Less conventional measures extend the boundaries of monetary policy

The Eurosystem therefore adopted non-standard instru‑ments such as balance sheet measures and forward

guidance,whichexertdownwardpressureonlonger-terminterest rates. The central bank thus continues to create morefavourablefinancingconditions,notonlyforbanksbut also for businesses and public authorities. Decisions on spending in the economyarenot influencedbyonespecific interest ratebut by thewhole rangeof interestratesapplicableintheeconomy.

Thesenon-conventionalmeasuresmayalsohaveunwel‑comesideeffects.For instance,thecontinuedflatteningof theyield curve in 2016 limits the scope forbanks toearnmoneyfrommaturitytransformation.Inthatregard,thebanksfundloansandlong-terminvestment(onwhichthey receive interest) mainly by means of short-termliabilities, including deposits (on which they pay inter‑est). Low long-term interest ratesmean that the banksprobablyhave to reinvest securities reachingmaturity inlower-yielding securities, thus risking further erosion oftheir interest margin.

Allthesame,theimpactofthelowinterestratepolicyonthebanking sector’sprofitability isnotnecessarilynega‑tive,atleastintheshortterm.Thebanks’netinterestin‑comeisdepressedbytheshrinkinginterestmargin,butatthesametimeitissupportedbythegrowthinthevolumeoflendingandtheimprovementinitsquality,whichalsoresult from the monetary measures. Those measures infactencouragetheeconomicrecovery,boostingdemandfor loans and placing borrowers in a better position tomeet their obligations. The APP also raises the value of thebanks’investmentportfolio,whiletheTLTROsreducetheir fundingcosts.But the longer the low interest rateenvironmentpersists, thegreatertheriskofpressureonthebankingsector’sprofitability,andhence itsability totransmitthemonetarystimulustotherealeconomy.

Thelowinterestrateenvironmentmayalsoimplyriskstofinancialstabilityinthebroadsense.Thus,itmaythreatenthefinancialhealthoflifeinsurersandpensionfunds,orleadtoanexcessivesearchforyield.

Finally, the non-conventional measures also come upagainstoperational limits.For instance,thespecificrulesof the APP – such as the original decision not to purchase assets offering an interest rate below the deposit facil‑ity rate,or theobligation toeffectpurchases inaccord‑ancewith the ECB capital subscription key –make themeasuresmoredifficult to implement.Theprogramme’sflexibility nevertheless allows the APP parameters to beadjustedsothatanyscarcityproblemscanbeovercome.In March 2016, for example, the Eurosystem raisedthe limits on purchases of securities issued by interna‑tional institutions and multilateral development banks. It is now permissible to hold 50% – instead of the


previous33% –perissuerandperissueofthosesecuri‑ties.Nonetheless,thescopeforadjustingtheAPPparam‑eters is still limited. For example, the Eurosystemwantsto prevent anymarket distortion and avoid acquiring adominant market position in securities.

The December decisions reflected those limits

In December 2016, the ECB Governing Council con‑sidered that the very accommodative monetary policystance should be maintained in order to strengthen the economic recovery and steer inflation back towards itstarget. In fact, according to the December projectionsproducedbytheEurosystem’sstaff,inflationwouldcometonomorethan1.7%in 2019.

The key interest rates were kept unchanged, althoughthe Governing Council confirmed that they would re‑main at or below their present levels for an extendedperiod of time, and well past the horizon for the netasset purchases. Regarding theAPP, theplannedperiodwas extended from the endofMarch 2017 to the endofDecember 2017, or beyond if necessary. That exten‑sionimpliesamorelastingpresenceonthemarket,andconsequentlymoresustainedtransmissionofthesupportmeasures. Nevertheless, the intensity of the measureswasreducedas,inthelightofebbingdeflationrisks,theGoverning Council also decided to reduce the monthly

netassetpurchasesfrom€80 billionto€60 billionfromApril 2017, thepaceadopted in the initialphaseof thepurchase programme. The reduction in the volume of monthly purchases and extension of the period of theAPP should alleviate anyproblems concerninga scarcityof securities and reduce the downward pressure on in‑terestrateswhilemaintainingthestrongstimulus. If theoutlook deteriorates or if financial conditions becomeinconsistent with further progress towards the inflationobjective, theGoverningCouncilwould consider raisingthe volume and/or extending the duration of the APP.Finally,toensurethesmoothimplementationoftheAPP,the Governing Council decided to relax certain param‑eterswitheffect fromJanuary 2017.Thus, therangeofmaturities for securities eligible for the PSPP, currentlyfrom two to thirty years,will extend fromone to thirtyyears.Moreover,theEurosystemwillifnecessarybeable,undertheAPP,topurchasesecuritiesyieldinganinterestratebelowthedepositfacilityrate.

The decline in real interest rates was weaker …

Whilenominalinterestratesfelltoahistoricalfloor,thatwaslesstrueofrealinterestrates.Infact,lowerinflationexpec‑tations,whichwerepartof thereasonfor theEurosystemmeasures, exerted upward pressure on real interest rates.Thus,thefive-yearrisk-freenominalinterestrateandtherateonnewcorporateloansforatermoffiveyearsorlesshave

CHART 17 REALINTERESTRATESDECLINEDLESSSHARPLYTHANNOMINALINTERESTRATES

(in%)

–3

–2

–1

0

1

2

3

4

2013 2014 2015 20162012

–3

–2

–1

0

1

2

3

4

2013 2014 2015 20162012

Nominal interest rate (a)

Inflation compensation (reverse sign, b) (1)

Real interest rate (a + b)

FIVE-YEAR RISK-FREE INTEREST RATEINTEREST RATE ON BANK LOANS TO NON-FINANCIAL CORPORATIONS FOR A FIVE-YEAR TERM

source : Thomson Reuters Datastream.(1) Measuredonthebasisofswapshedgingtheinflationriskintheeuroareaforafive-yearperiod.


exhibitedacleardownwardtrendinrecentyears,whilerealinterestratescalculatedonthebasisofinflationexpectationsderivedfromfinancialdatahavetendedtoremainstable.Inpractice, inflationexpectationsdeclinedtomuchthesamedegree as the nominal interest rate.

Since economic agents’ decisions on saving and invest‑mentareinfluencedbyrealinterestrates,fundingcondi‑tionsintheeconomy–atleastthosemeasuredbythesevery simple indicators – have eased less in recent yearsthanthedeclineinnominalinterestrateswouldsuggest,despite the significant monetary policy measures. It istherefore vital to bring inflation back towards 2% andanchor inflationexpectations around that level again sothatrealinterestratescanbesteeredappropriately.Hencethe importance of the announcement that theAPPwillremain in force until the Governing council is sure that inflationistendingtowardsitsobjective.

… while the real equilibrium interest rate is too low …

The low interest rate environment is not solely the re‑sultofmonetarypolicy,but is alsodue tonegative realdevelopments in theeconomywhicharedepressing theequilibriuminterestrate,i.e.therateatwhichsavingandinvestmentareinbalance,ortherateatwhicheconomicactivityachieves itspotential levelandinflation isstable.Structural forces, suchas the increase inexcess savings,lowerproductivitygrowthandgreater incomeinequalityintheeuroarea,butalsocyclicalfactors,particularlythedeleveraging initiated since the crisis and the reneweduncertainty, account for the current extremely low levelof theequilibrium interest rateboth in theEMUand inotheradvancedcountries.Accordingtosomeestimates,theequilibriumrateisactuallynegativeintheeuroarea.

Thelowequilibriuminterestrateobligesthecentralbanktopursuea low interest ratepolicy,because inorder toachievepricestability(andmacroeconomicstabilityinthebroad sense) monetary policy always tries to bring realinterestratesintheeconomyappropriatelyinlinewiththerealequilibriuminterestrate.Itispreciselybecauseoftheextremelylowlevelofthatrateandtheriskofanexces‑sivedeclineininflationexpectationsthattheEurosystemhas had to take non‑conventional measures to ensure thatthemonetarypolicystanceissufficientlyexpansion‑ary.Thelowinterestratethusreflectsadeeperproblem,namelyeconomicweakness.Atthesametime,thispolicyhelps to remedy thatweakness since it aims to rekindleeconomicactivityandhenceinflation.

In these circumstances, the economic recovery in theeuro area benefits not only from the low real interest

rates but also from the increase in the equilibrium in‑terest rate.TheEurosystemcan takemeasures todrivedown the former but has little or no influence overthe atter.

… which highlights the importance of fiscal policy and structural reforms in reinforcing the monetary stimulus

The Governing Council has already repeatedly stressedinitscommunicationthatotherpolicyspheresalsoneedto be used to ensure the structural continuation of the economicrecovery,supportedbythemonetarystimulus.Monetarypolicyisnottheonlyfactor;agoodpolicymixwhichcanactivatethevariousspheresiscrucial.

Aroleisthusassignedtoafiscalstancemoreconducivetogrowthintheeuroarea,withmaximumuseofthescopeofferedbytheSGPrules.Inthatregard,thelimitedfiscalleewayavailabletomosteuroareacountriesrequirescare‑fullyconsideredmeasurestoachieveabalancebetweensupport for aggregate demand and the maintenance of confidenceinpublicfinances.Forexample,aneutralshiftin public expenditure to the detriment of unproductiveitemsandinfavourofgrowth-friendlypublicinvestmentmeets that requirement. In addition, such a measureoptimises the beneficial effects of the low interest rate,whichrendersinvestmentprojectsmoreattractive.Higherpublicinvestmentinturnboostspotentialgrowthandtheequilibriuminterestrate.

Newstructuralreformsaimedatthefundamentalforcesbehindthelowequilibriuminterestratearelikewiseveryimportant. But the pace of reform was only moderatein 2016,whiletherearestillmanychallengesfacingtheeuroareacountries:continuingEMUintegration,raisingtheemploymentrate,stimulatingentrepreneurship,guar‑anteeingthesustainabilityofpensions,reducingthepro‑portionofnon-performingloansonbankbalancesheets,etc.Astructuralpolicy thataddresses theseproblems inasustainedmannerwillhelptorestoreconfidence,raiseproductivity, drive up the equilibrium interest rate andboostpotentialgrowth.

Inaddition,ariseintheequilibriuminterestratereducesthe risks that the low interest rate policy may implyfor financial stability, as it allows the central bank tonormalise its interest rates more quickly. In the euroarea,thereislittlesignsofarofwidespreadriskscausedby the low interest rate environment. In the FinancialStabilityReviewitpublishedinNovember 2016,theECBconsidersthattheimpactofthelowinterestratepolicyonbanks’profitability is fairlyneutral.Nor is thereanywidespread evidence of an excessive search for yield,


inordinate overvaluation of assets, or excessive creditexpansion. If such risks materialise, they are generallyspecific to certain countries or branches of activity, sothatprudentialpolicyisthebestwayofcontainingthemin thefirst instance.TheEuropeanSystemicRiskBoard

(ESRB) plays a key coordinating role here. Monetarypolicy can thus concentrate fully on maintaining pricestability.Nonetheless,theECBstilltakesaccountofanyadverse effects of its extremely accommodative policy,andkeepsaclosewatchonthem.

global economy and euro area - | nbb.be · by 25 basis points in december 2016. it also foresees...

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