What is the environmental impact of inflation

The year at a glance

** This overview covers the activities of the European Central Bank (ECB) in 2019. It was completed before the global coronavirus pandemic (Covid-19) broke out. Since then, the economic situation has changed fundamentally, and the ECB's monetary policy measures have been substantially expanded. As part of its mandate, the ECB will do whatever is necessary to support the euro area in this crisis. **

2019 marked the 20th anniversary of the introduction of the euro, and support for the common currency was stronger than ever among the people of the euro area. According to the November Eurobarometer poll, the approval rating was 76%.

Economic growth in the euro zone continued to weaken in the year under review and stood at 1.2% compared to 1.9% in the previous year. The ongoing expansion was supported by the favorable financing conditions, renewed employment growth and the slightly expansive financial policy course. At the same time, the uncertainty surrounding world trade weighed heavily on manufacturing and investment activity.

The situation on the labor markets in the euro area continued to improve in the year under review. The unemployment rate continued to fall to 7.6% and wage growth remained robust, around its long-term average.

Headline inflation in the euro area averaged 1.2% in 2019 (2018: 1.8%). This decrease was due to the smaller contribution of the two more volatile components of energy and food. Without these two components, the inflation rate in 2019 averaged 1.0%, as in the two previous years.

Against this background, the Governing Council took further monetary policy accommodation measures three times in a row in 2019. These included a new set of targeted longer-term refinancing operations, an expansion of forward guidance, a reduction in the interest rate on the deposit facility and the resumption of the asset purchase program (APP). At the end of 2019, the first signs of a stabilization in growth momentum and a slight increase in underlying inflation became apparent.

In the course of assessing our monetary policy measures, the Governing Council also deals with the consequences of any side effects. For example, a two-stage system was introduced for the interest on reserve balances, in which part of the banks' excess liquidity is freed from the negative deposit rate in order to ensure the bank-based transmission of monetary policy.

For the banks in the euro area, their structural earnings weakness continues to be a challenge, even if the capitalization of the sector with a hard core capital ratio of 14.2% is appropriate. In view of the high risk appetite in the financial and real estate markets, the vulnerability to falling asset prices as well as the risks in the growing non-banking sector increased further in the course of 2019. In coordination with the ECB, some euro countries took a number of macroprudential measures to limit systemic risks and increase their resilience to such risks.

In payments, the Eurosystem made further efforts to ensure the smooth functioning of the systems. This included the preparation work for a new, state-of-the-art real-time gross payment system that will replace TARGET2, and a new strategy for retail payments. The latter supports the development of a Europe-wide solution for payments at the Point of Interaction (POI) based on the market as a supplement to the successful single Euro Payments Area (SEPA).

The new overnight reference interest rate, the Euro Short-Term Rate (€ STR), has been published since October 2, 2019 and is expected to replace the EONIA in January 2022. The daily calculation of the € STR works well and the methodology has proven reliable.

The impact of climate change on the outlook for price stability and the financial system is and will remain an issue that the ECB is grappling with. In the course of this, it collects current information about the CO2-Intensity of banks' loan portfolios and develops an analytical framework for carrying out stress tests for the first time in the euro area banking sector with regard to climate-related risks. The ECB makes an active contribution to combating climate change through its own investment decisions and environmental protection measures. From 2008 to 2018, the CO2-Emissions and energy consumption per workplace are reduced by 74% and 54%, respectively.

Since 2019, the ECB has also been working harder to reach a broader audience beyond the financial markets and the usual specialist audience and to give people and their concerns even more attention. Against this background, inter alia organized the # EUROat20 competition and published a new series of explanatory videos and a monthly podcast.

Frankfurt am Main in May 2020

Christine Lagarde

President

After peaking in mid-2018, there was a clear and broad-based slowdown in economic growth in 2019 in an environment of sharply increasing uncertainty due to tense trade relations, which took place synchronously in the individual countries. Against this background, economic growth in the euro area continued to weaken - from 1.9% in the previous year to 1.2%. In a climate of persistent global uncertainty, the economic slowdown in 2019 was primarily due to weaker world trade. At the same time, the economic downturn was cushioned by favorable financing conditions, renewed employment growth with rising wages, the slightly expansive fiscal course in the euro area and the sustained - albeit weaker - global economic momentum. The labor market situation in the euro area continued to improve, while productivity growth slowed significantly. Inflationary pressures remained subdued overall. Lower energy and food price rises caused headline inflation to fall to 1.2%, while underlying inflation remained subdued. The favorable financing conditions once again benefited credit and money supply growth. The yields on government bonds from the euro area fell significantly, while share prices rose, mainly due to lower discount rates. Household wealth benefited from increases in the value of real and financial assets.

1.1 The global economy clearly lost momentum

A clear and broad-based slowdown in global economic growth in 2019 occurred synchronously in the individual countries

Global economic growth declined significantly over the course of 2019. After peaking in mid-2018, the global economy lost considerable momentum. The annual growth rate was well below the historical average and its lowest level since the global financial crisis (see Figure 1). The broad-based global slowdown in growth was synchronized in the individual countries. In large industrialized countries such as the United States, the United Kingdom and Japan, this development was preceded by above-average growth rates. In China, economic growth fell to its lowest level since 1990, which roughly corresponded to the currently estimated potential rate. In other major emerging economies, economic growth was generally subdued, partly due to a slow recovery after the recent recession.

illustration 1

Global GDP growth

The global economic slowdown was primarily due to lower output in the manufacturing sector and noticeable declines in growth in trade and investment. In the service sector, on the other hand, output growth weakened less sharply; Relatively robust growth in consumption and the sustained improvement in the labor market provided support here.

Trade and investment growth in 2019 significantly weaker due to significantly higher trade policy uncertainty

The uncertainty due to the tense trade relations persisted at a high level after a sharp increase and weakened the global economy. The trade conflict between the United States and China intensified, as evidenced by a number of different indicators.[1] Both countries increased tariffs on bilateral trade, which affected most goods by the end of 2019. When a provisional trade agreement was announced in December - after further negotiations between the two countries from mid-October - the uncertainty eased somewhat. The agreement was signed on January 15, 2020. Against the background of heightened trade tensions, the increased import duties led to a serious decline in trade activities. At the same time, increased uncertainty and the deteriorating economic climate in 2019 weighed on investment growth (see Figure 2).

Figure 2

World trade growth

Headline inflation down, but core inflation broadly stable

Global inflation remained subdued in 2019, which reflected the weak momentum in global economic growth (see Figure 3). In the OECD area, annual headline inflation as measured by the consumer price index fell from around 3% in the second half of 2018 to 2.1% in December 2019. The reasons for this were falling energy prices and a slower rise in food prices. The underlying inflation (excluding energy and food), on the other hand, remained relatively stable over the course of the year at around 2%.

Figure 3

Inflation rates in the OECD area

Crude oil prices fluctuated due to the dynamics of supply and expected global demand

Crude oil prices fluctuated over the course of the year. This reflected the supply dynamic in the first half of the year and expectations with regard to global demand in the second half of the year. For 2019 as a whole, the price of crude oil moved in a range between USD 53 per barrel and USD 74 per barrel. In the first half of the year, there was an upward trend in oil prices, which was supported by unexpectedly strong production cuts by the OPEC + countries (a group of large oil producers) and geopolitical tensions. In the second half of the year, prices fell on concerns about trade tensions and their potential impact on the global economy. The effects of the failure of oil supplies from Saudi Arabia after the drone attack on September 14th were short-lived, as the shock was cushioned, among other things, by extensive supplies and the rapid restoration of production capacity.

The euro depreciated against the currencies of important trading partners in the euro area

The nominal effective exchange rate of the euro fell by 1.6% over the course of 2019 (see Figure 4). Bilaterally, this was due to the depreciation of the euro against the US dollar and the Japanese yen. The euro also fell against the pound sterling, although the exchange rate fluctuated significantly over the course of 2019 due to the changeable developments around Brexit.

Figure 4

Euro exchange rate

Global growth outlook fraught with downside risks

At the end of 2019, the global economic outlook was marked by a slowdown in growth, as the economic cycle in the industrialized countries was already in its late phase and the Chinese economy gradually shifted to weaker growth. At the same time, the recovery in other emerging markets remained fragile. This outlook was fraught with uncertainty. At the global level, the downside risks to economic development predominated.[2] To the extent that manufacturing weakness spilled over into the service sector, the global economic slowdown could be more rapid. A stronger economic downturn in China could have a greater effect on the global economy. An escalation of the trade conflict would exacerbate the negative impact on global trade flows. The main danger in Europe was that the United States could impose import duties on certain goods from different countries. Overall, the heightened geopolitical tensions posed downside risks to global economic growth and global trade. Also, despite the orderly exit from the EU, future relations between the UK and the European Union were uncertain and the outcome of the negotiations continued to pose a downside risk. Furthermore, a drastic correction in global financial markets could reduce risk appetite and the real economy worldwide affect.

1.2 Slow economic growth in the euro area with continued improvement in the labor market

Annual real GDP growth in the euro area continued to decline in 2019, most recently at 1.2%, compared with 1.9% in the previous year (see Chart 5). In contrast to 2018, when the economic slowdown was due to both foreign and domestic demand, the weaker development in the year under review was mainly evidence of a noticeable slowdown in world trade in an environment characterized by ongoing global uncertainty. At the same time, economic expansion in the euro area continued to be supported by favorable financing conditions, renewed employment growth with rising wages, the slightly expansionary fiscal stance in the euro area and the continued - albeit weaker - global economic momentum.

Figure 5

Real GDP in the euro area

Domestically oriented sectors more resilient in 2019

Production growth in 2019 was driven by the service sector and construction; Both sectors showed continued strength given the robust domestic demand in the euro area. In industry, however, the economy continued to cool (see Figure 6). The main reason for this was the negative effects of weak foreign demand. By contrast, there were limited signs in 2019 that the service sector was adversely affected by weaker foreign demand.[3]

Figure 6

Real gross value added in the euro area by economic sector

In 2019, domestic demand once again made a positive contribution to growth in the euro area. The favorable financing conditions and the improved labor market situation had a positive effect here. Private consumption and consumer confidence remained robust in 2019 (see Box 1). Household final consumption expenditure was supported by increases in employment and wages, which resulted in a higher aggregate labor income. Corporate investment continued to develop moderately in 2019, after slowing gradually in 2018. Due to the far less dynamic external economic environment and the increased global uncertainty, companies made cautious investment decisions. Nevertheless, thanks to the favorable financing conditions, corporate investments continued to make a positive contribution to growth - regardless of the moderate development in corporate earnings and declining capacity utilization. The growth in investments in copyrighted products, which otherwise tends to be volatile, was particularly strong.[4] At the same time, investment in residential construction slowed after a strong and sustained recovery in previous years; the residential property markets in the euro area also lost momentum. This primarily reflected an increasingly limited supply of residential real estate, which was primarily due to a labor shortage, regulatory bottlenecks and the reduction of liabilities. These factors slowed growth in the construction industry over the course of 2019.

Box 1
Consumer spending and sentiment among private households remain robust

Overall, the service sector and retail trade continued to be robust in 2019 against the backdrop of the economic slowdown in the euro area, although growth in these sectors also weakened somewhat. Private consumer spending is an important component of demand in the service and retail sectors. For this reason, this box takes a closer look at consumer confidence in the euro area and the drivers of relatively resilient private consumption expenditure.

Consumer sentiment has stabilized and is more resilient than seen in other sectors

The economic slowdown in 2019 was primarily an expression of weaker world trade and increased global uncertainty; this mainly affected developments in the euro area industrial sector. Meanwhile, the service and retail sectors remained resilient despite a slight slowdown. This can be seen in Figure A, which shows the mood in different sectors in the euro area. The European Commission's economic assessment indicator (ESI) is a weighted average of the confidence values ​​in industry excluding construction (weight: 40%), in the service sector (30%), construction (5%), retail (5%) and in private Households (20%). The figure shows that the decline in confidence in more domestically oriented sectors (e.g. construction, services, retail, private households) is far less pronounced than in industry.

Figure A.

Confidence in the euro area by sector

Private consumption remained robust overall in 2019

The rise in private consumer spending in 2019 was supported by sustained growth in real disposable income, which in turn benefited from the robust state of the labor markets. Income from work benefited from sustained wage increases and other, albeit smaller, increases in employment. Furthermore, direct taxes as well as social contributions and transfers are likely to have a slightly increasing effect on labor income overall. In 2018, however, these factors still had a growth-inhibiting effect (see Figure B). However, the contribution of the operating surplus and property income, which tends to be closely linked to the economic trend, turned slightly negative in 2019, after having had a positive effect since 2015.

Figure B.

Private consumption expenditure and disposable income (real)

Determinants of consumer confidence

The European Commission's consumer confidence indicator includes the average results of four sub-indices, which relate to the perception of financial and economic developments in the past as well as corresponding future expectations for the next twelve months (see Figure C).[5] One sub-index depicts the assessment of the overall economic situation in the respective country, and the other indices relate to the financial situation of private households. The sub-indices show that private households rated their personal situation relatively more favorably. This was mainly due to the continued robustness of the labor markets, which largely shielded private households' income from the economic slowdown.

Figure C.

Private consumption spending and consumer confidence

The fact that consumer confidence in the euro area remained elevated in 2019 and supported private consumption is primarily due to the robust labor market situation and the associated wage increases, but also to favorable financing conditions and an improved financial situation of private households. Against the background of strong domestic and weak foreign demand, the ECB continues to monitor the current data closely. In this way, she wants to assess the risk of negative effects being carried over from the external to the domestic sector.

On balance, foreign trade made a negative contribution to economic growth in the euro area in the year under review. With the exception of exports to the United States, which rose - at a slower pace - the decline in exports was broad-based; it was primarily due to the weak development in capital goods and automobiles. Domestic trade in the euro area also contracted - as a result of disruptions in the production chains in the euro area, particularly in the area of ​​intermediate goods.

Sustained improvement in the labor market situation in the euro area with a clear slowdown in productivity growth

The labor market situation in the euro area continued to brighten in 2019

The further improvement in the situation in the euro area labor markets in 2019 (see Chart 7) was a main driver of the economy.

According to an analysis based on synthetic labor market indicators, the level of activity in the second quarter of 2019 was almost at its pre-crisis high. Measured in terms of the long-term mean, the labor market dynamic was still above average, although it recently weakened somewhat.[6] The good labor market development took place against the background of a growing labor supply, which partly reflected the higher labor force participation of older workers as a result of reforms to raise the statutory retirement age.[7]

Figure 7

Labor market indicators

Employment increased by 1.2% in 2019, which is a sharp increase compared to the development of GDP growth. The growth in labor productivity per employee amounted to 0.0% in the reporting year after 0.4% in 2018.[8] Despite the higher labor supply, the unemployment rate continued to decline and stood at 7.6% in 2019, roughly the same as in 2007. However, the spread of the unemployment rate across the euro countries remained high.

The digitization of the economy must be kept in mind

Digitization influences variables relevant to monetary policy

According to the literature, digitization affects a number of important economic variables that are relevant to monetary policy. The empirical evidence suggests that digitization may increase economic output and productivity, while the full effect on the inflation rate is still unclear.[9] According to the Index for the Digital Economy and Society (DESI) of the European Commission, the degree of digitization in the Member States with the lowest values ​​in the EU was around 40 points, in those with the most digitization around 70 points (see Figure 8). The connectivity sub-indicator was roughly the same in all EU countries. Conversely, there were greater differences in the areas of human capital, internet use, digital technology integration and digital public services.

Figure 8

DESI index for the digital economy and society 2019

Structural policy as an answer to important challenges

Implementation of economic policy recommendations only sluggish in 2019

The implementation of structural measures must be stepped up significantly in the euro countries in order to increase productivity and growth potential in the euro area, reduce structural unemployment and increase the resilience of the economy. Such measures should include Improve the functioning of the labor markets as well as the framework conditions for companies and increase competition in the goods and factor markets.[10] Structural measures are also required to cope with current and future challenges, for example resulting from demographic aging, digitization and climate change. The country-specific recommendations are tailored to each country and aim to strengthen growth and resilience. These recommendations are adopted by the member states in the framework of the European Council. In February 2019, the European Commission found that 95% of economic policy recommendations were either not followed at all or, at best, had "limited" progress in implementation.[11]

Economic support from a slightly expansionary fiscal course

Slightly higher general government deficit ratio in the euro area due to a slightly expansionary fiscal stance

After the fiscal course[12] had been largely neutral at the euro area level for five years in a row, it swung to slightly expansionary in 2019 (see Figure 9). This easing had a stimulating effect on the euro area. The main reason for this was the expansionary fiscal measures taken by some of the larger member states in the form of cuts in direct taxes and increases in government spending. According to the Eurosystem staff macroeconomic projections from December 2019, the general government deficit ratio in the euro area increased slightly to 0.7% in 2019. The lower fiscal balance reflected fiscal easing; lower interest expenditure had a compensatory effect, while the contribution of the cyclical component remained largely unchanged.

Figure 9

Public budget balance and fiscal rate

The general government debt ratio in the euro area continued to decline in 2019. At the end of the year it was 84.5%. However, a number of countries still had high debt ratios. The reduction in the aggregate debt ratio at euro area level was supported by favorable interest-growth differentials and positive - albeit falling - primary balances. Although no euro countries were subject to the corrective component of the Stability and Growth Pact (SGP) at the end of 2019, the European Commission found that eight countries had submitted budget planning for 2020 that posed a risk of non-compliance with the SGP targets. Most of these countries had debt ratios close to or more than 100%.[13]

1.3 Inflationary pressures remain subdued

The headline inflation rate for the euro area averaged 1.2% in 2019, after 1.8% in 2018.[14] This essentially reflected lower contributions from the two more volatile components of energy and food. Underlying inflation can be measured using, among other things, HICP inflation excluding energy and food. As in 2018 and 2017, this indicator showed a subdued development with an average of 1.0% in 2019, although an increase was recorded towards the end of the year (see Figure 10).

Figure 10

HICP inflation rate and component contributions

Lower energy and food inflation caused headline inflation to fall, while underlying inflation remained subdued

The main reason for the decline in average headline inflation in 2019 compared to 2018 was the development of the energy component. Total food price inflation only contributed 0.3 percentage points to headline HICP inflation in 2019, compared with 0.4 percentage points in 2018. The development of this HICP component during the year was mainly dominated by the volatile sub-component unprocessed food. The annual inflation rate for processed food fluctuated around 1.9% in 2019, slightly below the 2018 average. Two determinants of the inflation of processed food are the producer prices for food and the food raw material prices - determined on the basis of the farm-gate prices in the EU. From the increase in these two components, it can be concluded that the price increases were not fully passed on to consumers in a very competitive environment.

Like other measures of underlying inflation, HICP inflation excluding energy and food also moved largely sideways for much of the year under review. Despite the slight increase towards the end of the year, it remained below its historical average. Box 2 examines the relationship between underlying inflation and the business cycle, as well as broader economic developments since the global financial crisis. The subdued inflation of non-energy manufactured goods and services contributed to the subdued development of the HICP excluding energy and food. The price of non-energy industrial products rose by an average of 0.3% in 2019 compared to the previous year, which corresponds to the price increase rate in 2018 and the average since 2015. According to the indicators of price pressure occurring at various stages in the price-setting chain, the annual rate of change in producer prices for consumer goods excluding food remained largely stable over the course of the year, but was well above the average measured since 2015. This suggests that the increased costs were partly offset by retailers. Furthermore, the average annual rate of change in import prices for consumer goods excluding food was positive in 2019 - unlike in the previous year. was due to the depreciation of the euro. The rate of price increase for services showed certain fluctuations due to statistical changes in the price of travel.[15] If this monthly volatility is not taken into account, the rate of inflation in services moved sideways. On average, it was 1.5% in 2019, unchanged from the previous year. Compared to the average value since 2015, it was only slightly higher. Overall, increases in service prices - most of which have a high share of labor costs - continued to follow wage growth with a time lag.

Box 2
Explanation of the current inflation trend based on the euro area Phillips curve

Since 2013, the HICP inflation rate excluding energy and food has been consistently below its historical average. Initially, this could be explained by the considerable underutilization of the economy and other factors that dampened inflation. For the more recent past, however, a standard Phillips curve no longer provides any clear determinants of the weak inflation trend, as can be seen from the unexplained component of itemized inflation in Figure A. This gave rise to a new analysis of this fundamental economic relationship.[16]

Figure A.

Underlying inflation breakdown based on the Phillips curve

Determinants of inflation in the Phillips curve model

Essentially, the Philipps curve is based on the assumption that the economy and the associated load on the goods and labor markets should influence inflation. The high degree of underutilization of the economy in the wake of the global financial crisis had a dampening effect on inflation. The second phase of the recession in the euro area from 2011 to 2013 also provides a clear explanation for the weak development in underlying inflation from the beginning of 2013. And although many measures of economic activity and macroeconomic utilization returned to their average levels in 2018 and some even began to point to excess demand , underlying inflation remained below the 1999 average (1.3%).

In addition to economic activity, factors such as inflation expectations and foreign trade prices are also crucial to understanding inflation developments. Economic actors' inflation expectations are subject to a variety of influences. More recent developments in the rate of inflation (particularly in the case of energy) are decisive for the formation of short-term inflation expectations. Serious concerns about the credibility and achievability of a central bank's inflation target, on the other hand, can affect longer-term inflation expectations, even if these factors are difficult to isolate empirically.[17] Both market- and survey-based measures of inflation expectations fell from 2014 to 2017, which was reflected in their negative contribution to the underlying price developments over this period.[18] More recently, survey-based measures of longer-term inflation expectations for the euro area, particularly the results of the ECB's Survey of Professional Forecasters, have shown signs of slowing. However, only a small part of the subdued inflation trend can be explained by these measures.

In addition to macroeconomic capacity utilization and inflation expectations, indicators of foreign trade prices such as B. Price indices for crude oil and broad import price indices are important additional indicators with regard to the pricing of companies and thus the development of inflation. Foreign trade prices, and in particular energy prices, are usually quickly reflected in headline inflation, but have apparently only had a limited indirect effect on core inflation in recent years.[19] Overall, the development of the underlying price pressure up to 2017 seems to be explained quite well by standard factors. However, the recent weakness is difficult to fathom with this approach.

One of the reasons for this could be that the standard measures of overall economic utilization do not reflect all inflation-relevant economic developments. Against this background, Jarociński and Lenza (2018)[20] a measure of the macroeconomic utilization that is specially geared towards the inflation forecast and that shows a significantly higher degree of economic underutilization than a more conventional measurement of the output gap.

Overall, the Phillips curve remains a central element in analyzing and explaining the development of inflation. However, especially with a view to the recent development of the underlying inflation, it must be supplemented by findings from other instruments and approaches.

The domestic cost pressure, measured by the rise in the GDP deflator, increased on average in 2019. The rate of increase was above the 2018 average and the average from 2015 (see Figure 11). Annual growth in compensation per employee remained robust in 2019 as well. At an average of 2.0%, it was slightly below the mean observed in 2018, but above the average recorded since 2015. The development of social security contributions had a growth-inhibiting effect.[21] By contrast, wages rose more sharply in 2019 than in the previous year, which was in line with the renewed decline in the unemployment rate - regardless of the weaker economic growth in the euro area (see Chapter 1, Section 2). However, with productivity stagnating in 2019, the robust average increase in compensation per employee meant that the rise in unit labor costs had picked up. The accelerated growth of the GDP deflator reflected, in addition to the stronger increase in unit labor costs, a recovery in profit growth as measured by gross operating surplus; this had weakened significantly in the course of 2018.Given the sideways movement in productivity in the year under review, the recovery in earnings in 2019 was most likely due to improved terms of trade and developments in sectors that were less affected by the global economic slowdown and world trade.[22] These were, for example, the construction and real estate sectors, whose value-added deflators showed a high rate of increase. In the construction industry, this reached an average of 4.6% in 2019.

Figure 11

Breakdown of the GDP deflator

Longer-term inflation expectations fell over the course of 2019. In terms of inflation in five years' time, the ECB's Survey of Professional Forecasters (SPF) declined from 1.9% in the final quarter of 2018 to 1.7% in the final quarter of 2019. B. the five-year inflation-linked futures swap rate in five years declined. However, they stabilized towards the end of the year, although they were still at a low level.

1.4 Favorable financing conditions continued to support credit and money supply growth

The situation on the financial markets in the euro area in 2019 was mainly determined by the effects of the economic slowdown. The background to this development was permanently low inflation rates, politically induced uncertainty with the consequence of a low willingness to take risks at times and a renewed easing of the monetary policy stance. Both money market rates and longer-term bond yields fell markedly, while equity prices rose overall thanks to lower discount rates. The external financing flows of non-financial companies largely stabilized in the reporting year at a level that was well below their most recent high recorded in 2017. In contrast, bank borrowing and bond issuance remained solid thanks to favorable financing conditions, and net sales of unlisted stocks were robust thanks to increased merger and acquisition activity. The sustained increase in bank lending to the private sector and the low opportunity cost of holding M3 holdings helped support broad money supply growth. The favorable financing conditions reflected two aspects: the accommodative monetary policy stance of the ECB and the ability of the banking sector to pass the monetary policy stimulus on to companies and households in the form of favorable lending rates. The rising valuations of financial assets and real estate portfolios boosted household wealth, which in turn boosted private consumer spending.

Government bond yields in the euro area fell sharply in 2019 - recovery in sight since September

Government bond yields in the euro area fell significantly in 2019 and fell into the red in the long-term segment in the summer months. This was due to growing concerns about the extent and duration of the economic slowdown in the euro area and its impact on inflation developments. Risk-free rates also fell in the euro area due to various factors. These included monetary policy accommodation in the United States, a global tightening of risk sentiment triggered by the trade tensions between the US and China, but also by Brexit, and the increasing expectations of financial market participants regarding renewed monetary policy accommodation by the ECB. Following the announcement of the ECB's monetary policy package in September, slightly more positive macroeconomic data for the euro area and a slight stabilization in global risk sentiment contributed to a gradual recovery in government bond yields in the euro area. Nonetheless, the GDP-weighted average yield on ten-year government bonds in the euro area was 0.28% on December 31, 2019, 74 basis points below its level on January 1, 2019. Thanks to lower financial policy uncertainty, the yield spread of ten-year government bonds of the euro area compared to German government bonds narrowed, in some countries even significantly.

Figure 12

Ten-year government bond yields in the euro area, the United States and Germany

Share prices in the euro area up thanks to lower discount rates

Share prices in the euro area rose significantly in 2019. The overall index for the quotations of non-financial companies in the euro area rose by 20.7% over the course of the year, while the index for bank stocks from the euro area rose by 9.7% (see Chart 13). Lower discount rates were primarily responsible for the positive development in share prices. In contrast, earnings expectations remained weak and risk premiums - which reacted primarily to the course of the trade conflict between the US and China and the Brexit negotiations - weighed on prices.

Figure 13

Equity market indices in the euro area and the United States

Bank borrowing and securities issuance by non-financial corporations solid

Non-financial corporations' external financing flows broadly stabilized in 2019, well below their latest record high of 2017 (see Figure 14). Nonetheless, the growth in bank borrowing and bond issuance remained solid thanks to the favorable financing conditions, and net sales of unlisted shares also developed robustly thanks to increased merger and acquisition activity. In contrast, other sources of finance (including intra-group loans and trade credits) weakened. Net sales of listed stocks also fell because the cost of self-financing exceeded those of other types of financing. Bank lending rates continued to fall - largely in line with the development of market rates - and reached new all-time lows in the course of the year under review.

The additional easing of monetary policy implemented by the ECB in 2019 was reflected in more favorable financing conditions. This was due, among other things, to the fact that some of the measures taken - for example the third series of targeted longer-term refinancing operations (TLTRO III) and the graduated interest rate on reserves - were aimed at strengthening the banks' ability to act as intermediaries (see Chapter 2, Section 1). At the same time, banks made further progress in cleaning up their balance sheets by increasing their equity positions and improving the quality of their assets.

Figure 14

External financing of non-financial corporations in the euro area (net)

Private households benefited from increases in the value of property and financial assets

Household net wealth increased noticeably in the first three quarters of 2019, thereby boosting private consumption. Despite the slowdown in the dynamism of the residential property markets, the continued rise in housing prices benefited net wealth. This led to considerable valuation gains from the real estate portfolio of private households. There were also considerable valuation gains from financial assets. Rising house prices and favorable financing conditions also contributed to the gradual upward trend in the annual growth rate of home loans to households. The gross debt of private households - measured as a percentage of nominal gross disposable income - continued to be well above the average pre-crisis level.

M3 and credit growth recovered in 2019

Bank lending to the private sector performed solidly overall. Annual growth accelerated (adjusted for loan sales and securitisations as well as fictitious cash pooling) from 3.4% in December 2018 to 3.7% in December 2019. Of the loans, the largest contribution to growth was made by broad money supply (see the blue bar sections in Figure 16). At the same time, monetary inflows from outside the euro area were increasingly reflected in the M3 dynamic (see the yellow bars in Figure 16). Accordingly, M3 growth recovered in 2019 (see Chart 15). At the end of 2018, the cessation of net purchases under the asset purchase program had a dampening effect on M3 growth (see the red bars in Figure 16). Meanwhile, the reintroduction of asset purchases in November 2019 had only a limited impact on broad monetary aggregate growth in the year under review.

Figure 15

M3 and private sector lending

Figure 16

M3 and counterparts

Much of M3 growth attributable to higher stock of overnight deposits

A closer look at the instruments contained in M3 shows that the growth of the broad money supply continued to be dominated by overnight deposits, as the opportunity costs of holding liquid deposits were low given the very low interest rates and a flat yield curve. The rise in overnight deposits was driven by the sharp expansion in the holdings of households and non-financial corporations. As a result, the narrow monetary aggregate M1, which includes currency in circulation and overnight deposits, continued to grow strongly.

Against the backdrop of the economic slowdown in the euro area, prolonged downside risks and an inflation outlook that still fell short of the Governing Council's medium-term inflation target, the Governing Council eased monetary policy in three consecutive steps over 2019 . These sequential actions demonstrated the Governing Council's determination to act appropriately to steer inflation back towards a sustainable convergence with the Governing Council's medium-term inflation target. Given the time it took for these measures to have their full impact on the euro area economy, the Governing Council continued to closely monitor inflation developments and the transmission of unfolding monetary policies. At the same time, the Governing Council remained ready to adjust all of its instruments, if necessary, to ensure that the inflation rate - in line with its commitment to symmetry around below, but close to 2% - moves sustainably closer to the price stability target. At the end of 2019, 70% of the Eurosystem's total assets were attributable to monetary policy operations. The balance sheet total stabilized at € 4.7 trillion in 2019, corresponding to the figure reported at the end of 2018. As in the past, the ECB defused the risks associated with the large balance sheet total with risk-controlling measures.

2.1 First package of monetary policy measures to maintain extensive monetary policy accommodation in the face of increasingly negative external influences

After the economic outlook deteriorated at the end of 2018, incoming data also fell short of expectations in early 2019. This was due to weaker foreign demand and a number of country and sector-specific factors, which indicated that short-term growth could be less dynamic than previously assumed. At the same time, there was considerable uncertainty as to whether the growth-inhibiting factors in the euro area would be temporary or longer-term. This led to the question of how far the lower short-term growth would affect the medium-term prospects. Against this background, the Governing Council confirmed that the euro area's growth outlook is now fraught with downside risks. The persistent uncertainties in connection with geopolitical factors and the threat of protectionist measures, vulnerabilities in the emerging countries and the volatility in the financial markets are responsible for this development. The Governing Council stressed that monetary policy must continue to be characterized by prudence, patience and perseverance. Although growth in the euro area and the gradually increasing inflationary pressure would continue to be supported by the favorable financing conditions, the positive dynamism on the labor market and higher wage growth, the Governing Council reiterated the need for substantial monetary policy stimulus. This is the only way to ensure a continued sustainable convergence of inflation to a level of below, but close to, 2% in the medium term.

Weaker economy slowed inflation's approach to the medium-term inflation target and resulted in the introduction of the first package of measures

The current economic data remained weak in the spring as well, suggesting a considerable slowdown in the pace of growth, which would continue into 2019. The economy in the manufacturing sector slowed down particularly markedly. This was mainly due to negative external factors, as global growth and trade dynamics remained weak. The convergence of the inflation trend with the medium-term inflation target of the Governing Council was slowed down by the slower economic momentum.

In response to the significant weakening of the growth and inflation outlook, the Governing Council therefore adopted a package of measures at its March meeting to provide additional accommodative monetary policy stimuli. This should support the further build-up of domestic price pressures and headline inflation developments over the medium term and increase the resilience of the euro area economy in an environment of global uncertainty. The Governing Council adopted the following measures in detail: First, it decided to move the calendar-based component of the forward guidance on key interest rates further into the future. He based this decision on his expectation that the key interest rates of the ECB will remain at their current level at least beyond the end of 2019 and in any case for as long as necessary in order to ensure a continued sustainable convergence of the rate of inflation towards a level compatible with the medium-term target . Second, the Governing Council reiterated its intention to keep repayments of maturing securities acquired under the Asset Purchase Program (APP) beyond the point in time at which it starts to raise key interest rates and in In any case, continue to reinvest in full for as long as necessary in order to maintain favorable liquidity conditions and a high degree of monetary policy accommodation. In view of the connection between the forward guidance on key interest rates and reinvestments, the expected time horizon for reinvestments was automatically extended. This strengthened the forward guidance on key rates and confirmed the Governing Council's determination to act appropriately. Thirdly, in addition to the adjustment of the forward guidance on key interest rates, a new series of quarterly targeted longer-term refinancing transactions (TLTRO III) was announced. These should start in September 2019 and end in March 2021 and each run for two years. The aim of the new TLTRO series is to maintain the banks' favorable lending conditions and thus the supply of bank customers with loans at affordable conditions. Solid lending to the private sector promotes the implementation of consumption and investment projects by households and companies, thereby contributing to economic growth and the adjustment of inflation to the medium-term objective of the Governing Council. Fourth, the Governing Council agreed that the Eurosystem's lending operations would continue to be carried out as fixed-rate tenders with full allotment for as long as necessary and at least until the end of the reserve maintenance period starting in March 2021.

Following the announcement of the new TLTRO series, the Governing Council announced at its next monetary policy meeting that the exact terms of these refinancing operations would be announced at one of the upcoming meetings. The pricing of TLTRO-III transactions would include, in particular, a careful assessment of the bank-based transmission channel of monetary policy and the further development of the economic outlook. In view of the fact that the negative interest rate environment will last longer than originally expected, the Governing Council also pointed out that in its regular assessment it would also examine whether any side effects for bank intermediation in order to maintain the positive effect of negative interest rates on the economy would have to be mitigated if necessary.

Second round of additional monetary policy accommodation and falling confidence in the inflation outlook

Outlook for the euro area continued to be weighed down by negative global economic factors even in the middle of the year

As of the middle of the year, the latest information indicated that negative global economic factors - especially in connection with the persistent weakness in world trade and the more widespread and prolonged uncertainties in the external environment - continued to weigh on the outlook for the euro area. Manufacturing in the euro area was particularly hard hit by these factors.In addition, the rate of inflation measured by the HICP continued to slow, primarily due to temporary factors. The underlying inflation, however, has moved steadily sideways.

In view of the persistent uncertainties and their effects on the inflation outlook, the Governing Council noted the need to adjust the monetary policy course for the second time in 2019 and to provide further monetary policy impetus so that inflation continues to move towards its medium-term goal. Therefore, at its meeting in June, the Governing Council decided to strengthen the forward guidance on key interest rates by moving their calendar-based component further into the future. In this context, the Governing Council specifically expressed its expectation that the key interest rates will remain at their current level at least beyond the first half of 2020 and in any case for as long as necessary in order to ensure a continued sustainable convergence of inflation with the medium-term target. The Governing Council also reiterated its forward guidance on reinvestments. In connection with the pricing of the refinancing operations in the TLTRO-III series, the Governing Council decided to set the interest rate for the individual operations at a value of 10 basis points above the average interest rate for the main refinancing operations of the Eurosystem. However, a lower interest rate for TLTRO III would apply to banks whose net creditable lending exceeded a reference value. This could be reduced to the average interest rate on the deposit facility plus 10 basis points. With this pricing a balanced package had been achieved, taking into account both the solid development of bank lending and the importance of maintaining an accommodative monetary policy stance.

The outlook for the euro area was also negatively impacted in the summer months by the slowdown in global growth and weak world trade. In addition, the persistence of uncertainties continued to dampen the business climate, which was particularly evident in the manufacturing sector. Meanwhile, prices remained subdued and underlying inflation continued to move sideways. Market-based measures of longer-term inflation expectations stagnated at all-time lows seen after the June meeting. At the same time, the surveys indicated a sharp decline in longer-term inflation expectations.

Governing Council found that actual and projected inflation rates were consistently below its inflation target

Against this background, the Governing Council of the July meeting found that both actual and projected inflation rates were consistently below levels consistent with its target. He also indicated that he viewed the symmetry of his medium-term inflation target as an important element in promoting a sustainable convergence of the inflation rate with the inflation target. It was therefore considered important that the Governing Council demonstrate its determination and ability to act and show its willingness to further loosen monetary policy by adjusting all of its instruments if necessary in order to achieve the price stability objective. At the same time, the Governing Council made it clear that it was determined to act in accordance with its commitment to inflation target symmetry should the medium-term inflation outlook continue to lag behind its target. In this situation, the Governing Council therefore decided to reintroduce an “easing bias” in its forward guidance on key interest rates by expressing its expectation to leave key interest rates at the current level or at a lower level. The Governing Council also instructed the relevant Eurosystem committees to review certain options, including options for strengthening forward guidance on key interest rates, compensatory measures such as developing a tiered system for the interest on reserves and options regarding the size and composition of possible options new net purchases of securities. These announcements formed the basis for a comprehensive package of measures that could be adopted at the next monetary policy meeting if the inflation outlook does not improve in line with the target.

Third round of monetary policy accommodation with a comprehensive package of measures in response to persistently low inflation rates