1

Euro area economy and monetary policy

Līva ZorgenfreijaKrista Kalnbērziņa

Economists in Bank of Latvia31.03.2016

2

Eurosystem

♦ EURO AREA♦ OTHER EU COUNTRIES♦ COUNTRIES THAT HAVE UNILATERALLY ADOPTED EURO

Economic and monetary union – the countries with euro as their currency

4

Tasks of the Eurosystem

Basic tasks Further tasks

definition and implementation of monetary policy for the euro area consultation of stakeholders

the conduct of foreign exchange operations collects statistical information necessary in order to fulfil the tasks of the ESCB

the promotion of the smooth operation of payment systems.

authorises the issuance of banknotes within the euro area

the holding and management of the official foreign reserves of the euro area countries

maintains working relations with relevant institutions, and bodies, both within the EU and at the global level

the prudential supervision of credit institutions established in participating Member States contributes to the stability of the financial system

ECB’s primary objective – price stability

6

Euro area economy

7

The structure of the euro area economy

8

Euro area in the global contextPopulation (mil)

Eurostat, IMF WEO, World Bank

9

75% of the EA population live in Germany, France, Italy or Spain

Eurostat

Euro area population by country, 2014 (%)

10

Euro area in the global contextWorld GDP, 2014 (%)

World Bank

11

Germany and France contribute 50% to the GDP of the euro area

Eurostat

Euro area GDP by country, 2014 (%)

12

The largest sectors in euro area are public administration & defence and industry

Eurostat

Value added in euro area by sector, 2014 (%)

13

Euro area in the global contextGDP per capita, 2014 (thsd. USD)

World Bank

14

The levels of GDP per capita are very diverse across EA countries

Luxe

mbourg

Ireland

Netherlands

Austria

Finland

Belgium

Germany

France

EA-19Ita

lySp

ainCyp

rusMalta

Slove

nia

Portugal

Greece

Estonia

Slova

kia

Lithuania

Latvi

a0

10

20

30

40

50

60

70

80

90

100

20042014

Eurostat

GDP per capita (thsd. EUR)

15

Euro area in the global contextWorld exports (%)

Eurostat, IMF WEO, World Bank

16

The largest EA export partners are the US, the UK and China.

Eurostat

Euro area key export destinations, 2014 (%)

17

The largest export product group is machinery and transport equipment

Eurostat

Main product groups in euro area exports, 2014 (%)

18

Global economy

19

IMF forecasts moderate global growth

Source: IMF

Global GDP, %

19901992

19941996

19982000

20022004

20062008

20102012

20142016

20182020

-6

-4

-2

0

2

4

6

8

10

Advanced economiesEmerging and developing economies

20

Global commodity prices have dropped significantly since mid 2014

Global commodity prices (food (index), oil (USD/barel)

Avots: Bloomberg

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20160

500

1000

1500

2000

2500

0

20

40

60

80

100

120

140

160FoodOil (right axis)

-64%

21

Euro exchange rate has weakened against USD as euro area is struggling to return to stronger growth

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20132014

20152016

80

85

90

95

100

105

110

115

120

125

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

NEER (38)EUR USD

EUR/USD exchange rate, NEER-38 99Q1=100

Source: Bloomberg

22

Euro area economy

23

Moderate recovery continues in euro area

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

1.6

2.6 2.9 3.0

3.8

2.1

0.9 0.6

2.21.6

3.2 2.9

0.4

-4.5

2.11.6

-0.8-0.3

0.91.6

Euro area GDP, growth %

Avots: Eurostat

Euro area has nearly returned to pre crisis level, Latvia has still some catching up to do

Real GDP, index, 2008.g Q1=100

70.0

75.0

80.0

85.0

90.0

95.0

100.0

105.0

110.0

EA-19Ger-many GreeceSpainFranceItalyLatvia

Source: Eurostat, BoL calculations

2011 2012 2013 2014 2015-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1.6

-0.9-0.3

0.91.6

6.2

4.0

3.02.4

2.7

Euro area Latvia

Real GDP growth, %

20

00

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Inflation

Core in-flation

ECB target

25

Inflation in euro area, y/y, %

Avots: Eurostat

Inflation has been significantly below ECB target for a prolonged period of time

One of the main factors keeping inflation low is the drop in global oil prices

Inflation by main components, percentage points

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Services Energy NEIG Food Inflation

Source: Eurostat

Without stronger rebound of growth, there is little chance for a substantial decline in unemployment rates

Unemployment rate, % labour force

Avots: Eurostat I 2007VIII III X V XII VII II IX IV XI VI I 2014VIII III X0

5

10

15

20

25

30

Euro areaGermanyGreeceSpainFranceItaly

28

The rapid increase in sovereign debt levels raises serious concerns about its sustainability and future economic growth

EL IT PT BE CY ES EI FR AT SI DE NL MT FI SK LT LV LU EE0

20

40

60

80

100

120

140

160

180

200

2007 2015*

Public debt, % of GDP

EA average

*EC forecastsSource: EC

Budget deficit is still close to or above the 3% threshold in several euro area countries

Fiscal balance, % of GDP

Source: Eurostat, * European Commission forecasts

ES EL FR FI PT SI BE SK IT EI NL AT MT LV LT CY LU EE DE

-16

-14

-12

-10

-8

-6

-4

-2

0

2

2009 2015*

Political uncertainty in several countries continue to weigh on sovereign risk and inhibit future growth

10 year government bond yields, %

Avots: Bloomberg

2009 2010 2011 2012 2013 2014 2015 20160

5

10

15

20

25

30

35

Spain Italy Portugal

Greece France Germany

31

Monetary policy

32

Primary objective of the ECB – medium term price stability

Economic activity

Inflation

Inflation expectations

Interest rate

Exchange rate

The monetary transmission mechanism

33

Since 2009 world’s central banks are keeping rates close to zero, in recent years some have moved into negative territory

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016-2

-1

0

1

2

3

4

5

6

7ECB repo rateFED funds rateBoJ BoE bank rateRiksbank repo rateSwiss national bank LIBOR target rateDanish repurchase repo rate

Base rates of selected central banks (%)

34

On June 6, 2014 the ECB became the first leading central bank to introduce negative rates

→ Stabilize the price level in the monetary union

→ Enhance the monetary transmission mechanism

→ Lower the short term rates in the euro zone interbank market

→ Promote credit to the real economy -1 %

0 %

1 %

2 %

3 %

4 %

5 %

6 %

Deposit facility rate Rate on the main refinancing operationsMarginal lending facility rateAvots: ECB

Galvenās procentu likmes Eirosistēmā (%)

35

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016-100%

0%

100%

200%

300%

400%

500%

600%

EoniaEuribor 3m

Avots: Bloomberg

Due to the ECB’s loose monetary policy the interbank rates have fallen and are now in the negative territory

Eurosystem money market rates (%)

lowering of the main interest rates announcement of additional monetary stimulus

Sep -2014

TLTRO

Jun - 2014

covered bond purchase programme

asset-backed securities programme

expanded asset purchase programme

The standard monetary policy tools become less efficient in a low interest rate environment – time for non-standard measures

announcementstart

prolonging the APP lowering the interest

rate

Oct -2014

Nov -2014

Jan-2015 Mar-2015

Dec-2015

Jan-2016

lowering the interest rate extending the APP

TLTRO II

Mar-2016

37

What does the APP entail?EAPP (expanded asset purchase program)

CBPP3 (covered bond purchase program)

Avots: ECB

ABSPP (asset-backed securities purchase program)

asset-backed securities

PSPP(public sector purchase program)

government, municipal and supranational institution bonds

→ EUR 60 bn / month, from april 2016 EUR 80 bn/month→ 2015.03 – 2017. 03 and in any case until there is a sustained adjustment in the path of inflation that is consistent

with achieving inflation rates below, but close to, 2% over the medium term.→ Overall EUR 1.74 tr. (initially EUR 1.14 tr.)

covered bonds

start: 2014.10,so far EUR 19 tr. worth of assets bought

start: 2015.03,so far EUR 598 tr. worth of assets bought

start: 2014.09,so far EUR 158 tr. worth of assets bought

CSPP (corporate sector purchase program)

non-financial corporate sector bonds

start: 2014.06,

38

The impact of ECB’s monetary policy

39

Money market rates follow the base rates into negative territory

Avots: ECB

Base rates and interbank rates in the Eurosystem (%)

2014 2015 2016-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1Deposit facility rate Main REPO rate

Marginal lending facility rate EONIA

EURIBOR-3M

MFI lending rates to NFCs on newly issued loans * (%)

Avots: ECB SDW, Latvijas Bankas aprēķini

MFI lending rates to the private sector have decreased considerably after the start of the APP

2004

2004Q32005

2005Q32006

2006Q32007

2007Q32008

2008Q32009

2009Q32010

2010Q32011

2011Q32012

2012Q32013

2013Q32014

2014Q32015

2015Q32016

0

1

2

3

4

5

6

7

8 GermanyEstoniaFinlandFranceGreeceIrelandItalyLithuaniaLatviaPor-tugalEuro area

* Ar sākotnējo termiņu līdz 1 gadam

41

Lending to the private sector has recovered since the introduction of non-standard measures

Jan-14Fe

b-14

Mar-14Apr-1

4

May-14Jun-14

Jul-14

Aug-14Se

p-14Oct-

14

Nov-14

Dec-14Jan-15

Feb-15

Mar-15Apr-1

5

May-15Jun-15

Jul-15

Aug-15Se

p-15Oct-

15

Nov-15

Dec-15Jan-16

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

Households NFCs

MFI loans to the private sector (YoY, %, s.i.)

Avots: ECB

42

Post-APP stock indices rallied, recently – more global uncertainty – markets are falling

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 201630

50

70

90

110

130

150

170

190

210

MSCI World ASV S&P 500 EuroStoxx 50

US, European and world stock indices (Index 31.01.2004=100)

Avots: Bloomberg, LB aprēķini

APP has provided huge financing relief for governments

2009 2010 2011 2012 2013 2014 2015 20160

5

10

15

20

25

30

35

0

5

10

15

20

25

30

35

40SpainItalyPortugalFranceGermanyGreece

01/2014

02/2014

03/2014

04/2014

05/2014

06/2014

07/2014

08/2014

09/2014

10/2014

11/2014

12/2014

01/2015

02/2015

03/2015

04/2015

05/2015

06/2015

07/2015

08/2015

09/2015

10/2015

11/2015

12/2015

01/2016

02/2016

03/2016

0

1

2

3

4

5

6

7

0

2

4

6

8

10

12

14

16

18

20

10 year government bond yields, %

Source: Bloomberg

ECB cuts interest rate and announces additional monetary policy measures

ECB announces and launches APP

ECB cuts rates and announces enlarging APP

44

Divergence in monetary policy stance is also having an impact on exchange rate, thus supporting growth

80

85

90

95

100

105

110

115

120

125

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

NEER (38)EUR USD

EUR/USD exchange rate, NEER-38 99Q1=100

Source: BloombergJan-13

Mar-13

May-13Jul-1

3

Sep-13

Nov-13Jan-14

Mar-14

May-14Jul-1

4

Sep-14

Nov-14Jan-15

Mar-15

May-15Jul-1

5

Sep-15

Nov-15Jan-16

100

102

104

106

108

110

112

114

116

118

120

0.8

0.9

1

1.1

1.2

1.3

1.4

1.5

NEER (38) EUR USD

ECB cuts interest rate and announces additional monetary policy measures

ECB announces and launches APP

ECB cuts rates and announces enlarging APP

45

Significant monetary expansion has produced limited macroeconomic impact so far

2013 2014 2015 2016 2017 2018-0.5

0.0

0.5

1.0

1.5

2.0

2.5

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

1.35256927198255

1.746234764548141.76691254181933

September 2015 forecastDecember 2015 forecastMarch 2016 forecastReal GDP

Euro area GDP growth (%), inflation (%) and ECB forecasts

2013 2014 2015 2016 2017 20180.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

0.0727085168393593

1.27182216282222

1.55482260764603

September 2015 forecastDecember 2015 forecastMarch 2016 forecastInflation

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