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Further flattening bias

MNI (London)
     LONDON (MNI) - Account of the monetary policy meeting of the Governing
Council of the European Central Bank, held in Frankfurt am Main on Wednesday and
Thursday, 12-13 September 2018
     Full text can be found here:
1. Review of financial, economic and monetary developments and policy options
Financial market developments
Mr Coeure reviewed the latest financial market developments since the Governing
Council's previous monetary policy meeting on 25-26 July 2018.
     Heightened volatility had been observed in the currencies of some emerging
market economies, especially Argentina and Turkey, but also Brazil and South
Africa. In fixed income markets, Argentina's and Turkey's sovereign bond spreads
had widened proportionately more than those of other emerging markets, with only
limited signs of spillovers.
     In advanced economies, the euro/US dollar exchange rate had exhibited some
volatility, with the euro first falling to its lowest level in more than a year
after the Governing Council's July monetary policy meeting, only to reverse most
of this movement thereafter. From around mid-April, and increasingly since
mid-June, there had been a reduction in net long speculative positions in euro
to broadly neutral levels, which might have contributed to amplifying movements
in the euro/US dollar exchange rate.
     Turning to bond markets in the United States, domestic demand and monetary
policy could be expected to continue putting upward pressure on the ten-year
government bond yield. At the same time, increasing global risk and safe haven
flows into US Treasuries had likely exerted downward pressure on yields, which
roughly offset the upward pressure. Similarly, global risk aversion had likely
amplified the upward pressure on the US dollar, exerted as a result of improved
economic prospects and tighter monetary policy in the United States.
     In the euro area bond markets, prices in the Italian sovereign bond market
had been quite volatile over the previous few weeks. Of late there had been some
stabilisation, but at notably higher levels than prior to the formation of the
new Italian government. Spillovers from the Italian sovereign bond market to the
rest of the European bond markets had, however, been very limited.
     In equity markets, the EURO STOXX 50 index had fallen by around 5% since
the Governing Council's July monetary policy meeting and was down by more than
10% from its peak in January 2018. One of the drivers of this decline had been
European banks, as evidenced by the underperformance of the EURO STOXX Banks
index. By contrast, US equity prices had increased continuously since the
correction in spring 2018, with the Standard & Poor's 500 index presently 8%
above its level at the beginning of 2018.
     Finally, with regard to monetary policy expectations, the overnight indexed
swap (OIS) curve had shown various episodes of flattening after the Governing
Council's monetary policy meeting on 13-14 June 2018, which indicated that
markets expected a slower pace of rate normalisation. The expected date of a
first increase in policy rates had, however, not changed materially since 25-26
July. A first 10-basis point increase in the ECB's deposit facility rate was
currently priced in for the fourth quarter of 2019, while survey-based
information suggested a somewhat earlier timing, which might in part reflect the
presence of negative term premia in OIS rates.
     The global environment and economic and monetary developments in the euro
Mr Praet reviewed the global environment and recent economic and monetary
developments in the euro area.
     Regarding the external environment, the global economic expansion was
continuing at a steady pace, at rates close to potential but with substantial
cross-country divergences. Inflation and wage dynamics had gained some momentum.
At the same time, global trade had decelerated, while protectionist threats
persisted. Brent crude oil prices had risen by 8% (in US dollar terms) since the
Governing Council's July monetary policy meeting, and non-oil commodity prices
had fallen by 2.3%. The euro had appreciated somewhat in nominal effective terms
but had depreciated slightly against the US dollar.
     Turning to the euro area, recent data indicated that the moderation in the
first half of 2018 had reflected a pull-back from very high growth in the
previous quarters, mainly on account of weaker export demand. Since the
Governing Council's July meeting, high-frequency indicators had stabilised and
remained at elevated levels, underlining the overall robustness of economic
activity. Private consumption had continued to grow at a robust pace in the
second quarter of 2018, supported by the ongoing rise in labour income. Strong
demand and earnings remained supportive of business investment. Surveys showed
that capacity utilisation in the capital goods-producing sector had remained at
all-time highs. At the same time, euro area trade momentum had continued to
moderate in May. This weakening in momentum reflected mainly a deceleration in
extra-euro area trade, especially with Asia, and was concentrated in the trade
of intermediate goods.
     These developments were also reflected in the September 2018 ECB staff
macroeconomic projections for the euro area, which projected real GDP growth at
2.0% in 2018, 1.8% in 2019 and 1.7% in 2020, with real GDP growth revised down
by 0.1 percentage point for both 2018 and 2019. The revisions were mostly
attributable to a weaker than previously expected contribution from net trade,
reflecting downward revisions to foreign demand and a stronger effective
exchange rate of the euro. These effects offset the upward impact on domestic
demand stemming from lower lending rates and some fiscal stimulus. The ECB staff
projections stood at the lower end of other available forecasts for 2018 and
2019, and at the upper end of the range for 2020.
     Turning to price developments, according to Eurostat's flash estimate,
annual HICP inflation was 2.0% in August, down from 2.1% in July, with HICP
inflation excluding energy and food edging down to 1.0%, from 1.1%, over the
same period. Measures of underlying inflation remained muted but were on a
gradually improving path. Incoming data supported the assessment that domestic
cost pressures were strengthening and broadening. In the domestic supply chain,
producer price inflation for both goods and services was increasing, and prices
of imported consumer goods were again rising. As regards wage developments, the
annual growth in compensation per employee had increased to 2.3% in the second
quarter of 2018, up from 1.9% in the first quarter.
     In the September ECB staff projections, headline inflation was expected to
stand at 1.7% in each year of the projection horizon, unchanged from the June
Eurosystem staff projections. The stable path of annual average inflation rates
continued to mask a decline in the annual growth rate of the energy component -
as the impact of the past increases in oil prices faded - which was offset by
gradually rising underlying inflation as supply constraints became increasingly
binding. The September projections were in line with the forecasts of other
international and private sector institutions.
     Market-based inflation expectations were largely unchanged since the
Governing Council's July monetary policy meeting.
     Financial conditions had tightened to some degree, while the cost of
financing for non-financial corporations (NFCs) and households remained
favourable. The expected timing of a first increase in ECB policy rates was
largely unchanged. Euro area equity markets had declined since the Governing
Council's July meeting, with earnings expectations broadly unchanged. The
overall cost of financing for euro area firms had remained very favourable by
historical standards.
     Turning to money and credit developments, M3 growth had moderated in July
to 4.0%, partly reflecting volatility and base effects. At the same time, the
sources of money creation had continued to shift from the asset purchase
programme (APP) towards private credit. Euro area bank lending rates remained
favourable and stood close to historical lows. The composite cost of borrowing
for NFCs had decreased to 1.6% in July, while the composite rate on loans to
households for house purchase had remained stable at 1.8%.
     Regarding fiscal policy, the euro area fiscal stance, as measured by the
change in the cyclically adjusted primary balance, was projected to move from
broadly neutral to mildly expansionary in 2019.
     Monetary policy considerations and policy options
Summing up, Mr Praet concluded that, since the Governing Council's July monetary
policy meeting, financial conditions had tightened somewhat, while borrowing
conditions for households and firms remained very favourable.
--MNI London Bureau; tel: +44 203-586-2225; email:
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