The euro area: current status and challenges ahead

In his speech, Luis de Guindos, Vice-President of the European Central Bank (ECB), reviews the economic developments in the euro area, explains the recent monetary policy decisions of the ECB and reflect on the necessary reforms of Economic and Monetary Union, or EMU: Economic growth in the euro area remains solid and broad-based, as confirmed by the latest data. Preliminary figures show that real GDP grew by 0.4% quarter-on-quarter during the second quarter of 2018. In the first half of 2018, growth weakened from its very high rates of last year, partly reflecting lower exports, compounded by temporary supply-side constraints at national and global level.

Recent economic developments
Although growth has slowed earlier than anticipated, we expect the expansion to continue. In fact, the current expansion is shorter in length and smaller in size than historical averages. It has lasted just five years and real GDP is now 10% above the trough in the first quarter of 2013. In the past, growth phases lasted, on average, seven and a half years from trough to peak, with GDP increasing 21% over the same period.While risks surrounding the euro area growth outlook remain broadly balanced, uncertainties emerging from increased global protectionism, the finalisation of the Brexit negotiations and vulnerabilities in emerging markets have become more visible than a few months ago.
The ongoing expansion has led to strong employment gains. Since the beginning of the recovery, around 8.4 million jobs have been created. Euro area unemployment declined to 8.2% in July, the lowest level in almost ten years. This is particularly relevant in Spain, where unemployment declined by almost 11 percentage points from the peak of the crisis, to 15.4% currently. Almost two million jobs (1.9) have been created since the start of the recovery.
(Un)emplayment
Thanks to the recovery in labour markets, consumer spending is still robust. The steady rise in compensation per employee has increased household disposable income. Moreover, consumption benefits from an easier transition from unemployment to employment and increased job security. Lower unemployment not only pushes up the disposable income of those who find a job, but also reduces the perceived risk of job loss, giving workers less incentive to hold precautionary savings.
The investment outlook remains solid on the back of improving profitability and favourable financing conditions. According to the July bank lending survey, credit standards for loans to enterprises and households have loosened further. Moreover, net demand for all types of loans has increased and is expected to grow in the next quarter too, supporting loan growth. In Spain, credit standards for new loans eased across all segments. While net demand for loans to enterprises remained unchanged, it increased for loans to households. We are therefore confident that the underlying strength of the euro area economy will continue to support the sustained convergence of inflation to our aim in the medium term.
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Monetary policy stance
The Governing Council carefully reviewed the progress achieved towards a sustained adjustment in the path of inflation, guided by three criteria: convergence, confidence and resilience. For convergence, headline inflation should be on track to reach levels consistent with the Governing Council’s inflation aim of below, but close to, 2% over the medium term. In line with this criterion, the June Eurosystem staff projections see headline inflation reaching 1.7% in each of the next three years. These are the latest in a series of projections that have pointed to a convergence of headline inflation towards the Governing Council’s inflation aim.
Regarding confidence, uncertainty around the projected path of inflation has diminished. Moreover, underlying inflation has increased from the very low levels observed in 2016 and is expected to rise amid an expanding economy, high levels of capacity utilisation and labour market tightening. Stronger underlying inflation pressures, in turn, should pass through to headline inflation. In terms of resilience, the projected path of inflation is expected to be maintained even after a gradual ending of net asset purchases.
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EMU governance
The ECB’s monetary policy measures introduced since 2014 have been essential in supporting the robust recovery and paving the way for inflation to return towards our objective. Similarly, the removal of some of the institutional and structural factors that contributed to the crisis helped maintain that recovery. Nonetheless, the architecture of EMU is still incomplete in many ways. Further reforms are needed to make the financial sector more stable. As the euro area’s financial system is predominantly bank-based, completing the banking union remains a key priority. We gladly welcome the agreement on the European Stability Mechanism, or ESM, as the backstop for the Single Resolution Fund. If implemented swiftly, it will create confidence in the effectiveness of resolution and make the sector as a whole more stable. Most importantly, we need to make headway in establishing the third pillar of the banking union, the European Deposit Insurance Scheme, or EDIS. Ongoing discussions have been held up on the premise that risk reduction must come before risk-sharing. However, substantial risk reduction has already taken place. The significant banks’ Common Equity Tier 1 ratios – a key indicator of bank health – are now 67% higher than they were ten years ago. And further reduction of non-performing loans and toxic assets in the portfolios of some large banks is under way.
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Solidifying the institutional architecture of EMU is essential in order to foster cohesive economic performance without fragmentation or excessive imbalances. Monetary policy has played the key role since the financial crisis but cannot remain the only game in town. We now need action in other policy areas – notably fiscal policy and structural reforms. There is a need for responsible fiscal policy, given the levels of public debt. Some countries should take advantage of the ongoing recovery and favourable financial conditions to reduce debt burdens, whereas countries with fiscal space should increase their public investment. Likewise, significant steps should be taken on the structural policy side, with a view to increasing potential growth in the medium term. Measures to improve the functioning of labour and product markets and to strengthen procedures for the correction of macroeconomic imbalances take prominence here.
A robust economy relies on sound economic governance. Reforms at the national and EU level are needed to uphold a stable financial system and a resilient monetary union. A common stabilisation function, which − in the spirit of a true counter-cyclical fiscal policy instrument – would maintain convergence in the event of large shocks, is an overriding priority. Completing the banking union with the establishment of EDIS, its third pillar, and firm moves towards capital markets union, promoting deep and liquid bond and equity markets, are necessary reforms of the financial sector. Attaining these goals is highly relevant for financial stability, further integration, private risk-sharing and economic growth.
You can read the full version on the website of the ECB.
Source: www.ecb.europa.eu/