Economic Bulletin Issue 1, 2024

Non-energy commodity prices have been stable amid slightly higher metal prices, but lower food prices. Since the December meeting of the Governing Council, metal prices have increased by 1%, driven mainly by higher prices for tin, lead and aluminium. Some volatility was seen in aluminium prices owing to worries about growing tightness in the aluminium market as the UK government imposed sanctions on Russian metals trading, and an explosion at a fuel depot in Guinea in December raised fears of a bauxite shortage that could affect aluminium production in China. Food commodity prices have declined by 1.7% on the back of falling soybean and grain prices.

In China, economic activity slowed in the fourth quarter of 2023 as the real estate sector continues to pose headwinds. Quarter-on-quarter real GDP growth slowed to 1.0% in the fourth quarter of 2023, down from 1.5% in the previous quarter. For the year 2023 as a whole, GDP growth reached 5.2%, which is well in line with the government’s growth target of “around 5%” for 2024. The real estate sector is still acting as a drag on the economy. House prices continue to decline, while construction activity remains low, weighing on overall investment. Although consumer spending growth is positive in year-on-year terms, consumption of goods and services related to housing (such as furniture) is still contracting. Meanwhile, annual headline CPI inflation rates remained in negative territory in the fourth quarter, with prices falling by 0.3% in December, owing primarily to lower food prices. By contrast, annual core inflation remained positive at 0.6% in the same month. In the near term, inflationary pressures are likely to remain subdued, reflecting low food prices alongside weak domestic and external demand.

In Japan, consumer spending is showing signs of a modest recovery, while inflationary pressures persist. Economic activity indicators point to a gradual strengthening of domestic demand, as consumer confidence is improving amid expectations of higher wages. Nevertheless, uncertainty related to the economic impact of the New Year’s Day earthquake in central Japan prevails, but at this stage supply chain disruptions appear to be relatively limited. Meanwhile, headline consumer price inflation slowed in December to 2.6%, down from 2.8% in the previous month. At the same time, core inflation picked up slightly by 0.1 percentage points, to reach 2.8% in December, signalling persistent underlying price pressures. While the Bank of Japan kept its policy rate unchanged in December, a shift towards a tighter monetary policy stance in 2024 is widely expected.

In the United Kingdom, economic activity remains modest, while inflation is expected to ease further. GDP growth in the third quarter of 2023 was revised downwards to ‑0.1% in quarter-on-quarter terms. Recent high frequency data signal greater resilience, suggesting that GDP growth improved modestly in the fourth quarter of the year. Looking ahead, economic activity is expected to remain subdued in the coming quarters, as past monetary policy tightening and higher financing costs for firms are expected to weigh on demand. However, a recent fall in mortgage rates has stimulated new mortgage borrowing and could boost consumer spending to some extent. Headline CPI inflation surprised mildly on the upside in December, rising by 0.1 percentage points year on year, up to 4.0%, having fallen sharply in previous months. Inflation is expected to continue to decline in the months ahead, albeit more slowly, as pressures stemming from still elevated wage growth are expected to persist, reflecting continued tightness in the labour market.

Private consumption growth remained weak in the last quarter of 2023, reflecting continued subdued spending on goods. This was indicated by the ongoing weakness in retail sales volumes, which in October and November stood, on average, at the same level as in the third quarter of 2023. At the same time, in the fourth quarter of 2023, new passenger car registrations stood 0.6% below their third-quarter level, after a strong recovery in the third quarter resulting mainly from orders of electric cars that had previously been delayed. While the European Commission’s indicator for consumer confidence improved further in December, it remains well below its long-term average.

Incoming survey data continue to point to overall weakness in spending on goods alongside strong spending on services at the beginning of the year. The Commission’s indicators for expected retail trade business and for expected major purchases by consumers remained subdued in December 2023, despite a small improvement in the latter. By contrast, there was no strong downward correction in expected demand for contact-intensive services, which continued to hold up in December, remaining above its historical average (Chart 7). Similarly, the ECB’s Consumer Expectations Survey for December suggests resilient expected demand for holiday bookings. Likewise, the ECB’s recent contacts with the non-financial sector indicate that demand for contact-intensive services is likely to remain relatively strong, while demand for goods, particularly durable goods, is expected to remain weak. The transmission of tighter financing conditions to the real economy is likely to continue to curb household borrowing, resulting in high savings and keeping consumer spending growth subdued in the near term. At the same time, consumer spending should benefit from improving purchasing power on the back of falling inflation and a still resilient labour market.

Housing investment is likely to have fallen further in the fourth quarter of 2023, as shown by hard and soft indicators. Building construction output – a leading indicator for housing investment – fell by an average of 1.1% in October and November compared with its average level in the third quarter. In addition, survey-based activity measures, such as the European Commission’s indicator for building construction activity in the last three months and the PMI for residential construction, remained in contractionary territory until December 2023, although they improved slightly in the last two months of the fourth quarter of the year (Chart 8, panel b). According to the European Commission business and consumer survey on factors limiting construction activity, insufficient demand was cited by firms more frequently in the fourth quarter than in the third quarter of 2023 and remained the most cited factor, followed by labour shortages. Building permits for residential buildings (measured by floor space) increased in September but continued to fall significantly overall in the third quarter after five consecutive quarters of decline. This sustained downward trend in building permits indicates that the momentum in housing investment is likely to remain weak in the near future, which is consistent with subdued household borrowing for house purchases.

Food inflation continued to decline, to 6.1% in December from 6.9% in November, but remained elevated (Chart 10). The decrease was driven by slower dynamics in processed food prices (5.9% year-on-year growth after 7.1% in November). This reflected declines in energy costs and food commodity prices as measured by, for instance, euro area farm gate prices. While unprocessed food price inflation increased from 6.3% in November to 6.8% in December, this reflected a base effect from developments one year earlier rather than the latest price dynamics.

HICP inflation excluding energy and food (HICPX) decreased further from 3.6% in November to 3.4% in December. In terms of components, non-energy industrial goods (NEIG) inflation declined from 2.9% to 2.5%, reflecting the gradually fading impact of past shocks. Services inflation was unchanged at 4.0% in December. The relatively greater persistence in services inflation is in line with strong wage growth and the more prominent role that labour costs play in the production of services.

Producer and import price pressures continued to remain negative across all main industrial categories (Chart 11). At the early stages of the pricing chain, producer price inflation for domestic sales of intermediate goods was negative and unchanged (-5.3% in November and October). The annual growth rates of import prices for intermediate goods also remained significantly negative, although slightly less so than in the previous month (-7.8% after -8.3% in October). At the later stages of the pricing chain, the annual growth rates of producer prices for non-food consumer goods continued to decline to 2.7% in November, down from 3.0% in October, reaching the lowest level since September 2021. Import price growth for non-food consumer goods edged down from -0.4% to -0.6%. The same unwinding tendencies hold for producer prices and import prices in the manufactured consumer goods segment, confirming the general gradual easing of pipeline pressures on consumer goods prices.

Measures of underlying inflation in the euro area continued to decrease, as the impact from past shocks fades and demand eases amid tighter monetary policy (Chart 12). The range has been declining and narrowing since July 2023, but remains relatively high, as the impact of past shocks has yet to fully dissipate for most measures. The Persistent and Common Component of Inflation (PCCI) remained at the bottom of the range, declining further to 1.9% in December. HICPXX inflation (HICPX excluding travel-related items, clothing and footwear) decreased at the same rate as the HICPX, to 3.4% in December from 3.6% in November. The Supercore indicator, which includes cyclically sensitive HICP items, continued its decline from 4.4% in November to 4.0% in December, but remains relatively high. Domestic inflation (comprising items with a low import content) is also moderating from more elevated levels than other measures. It declined to 4.5% in December from 4.7% in November. The higher level and more gradual easing of this indicator primarily reflects the large share of services items included in it, particularly those sensitive to wage pressures.

Wage growth measures had been moving broadly sideways recently, at elevated levels. The latest available data refer to the third quarter of 2023 and show an increase in the annual growth rate of negotiated wages to 4.7% from 4.4% in the second quarter of 2023. The forward-looking wage trackers signal continued high wage pressures, although with some tentative signs of a cooling down by the end of 2023. Actual wage growth, as measured by compensation per employee and compensation per hour, decreased in the third quarter of 2023 to 5.3% and 5.2% respectively, down from 5.5% and 5.3% in the second quarter. Labour costs meanwhile account for the largest contribution to domestic price pressures, as measured by the annual growth rate of the GDP deflator, while the contribution of unit profits weakened in the third quarter of 2023 from a historical high in the first half of the year.

Euro area near-term risk-free rates ended the review period broadly in line with the levels prevailing around the time of the December Governing Council meeting. The euro short-term rate (€STR) averaged 3.90% over the review period. Excess liquidity decreased by around €63 billion to stand at €3,521 billion. The overnight index swap (OIS) forward curve, which is based on the benchmark €STR, remained stable for short-term maturities after the Governing Council’s widely expected monetary policy decision in December to keep the key ECB policy rates unchanged. Short-term forward rates for horizons beyond the January 2024 Governing Council meeting were, however, subject to heightened volatility over the review period as markets continued to focus on the pace of disinflation and the expected monetary policy adjustments. Overall, the priced probability of a first rate cut in March and April 2024 edged down. At the end of the review period markets had fully priced in a rate cut of 25 basis points for June and cumulative rate cuts of 133 basis points by the end of 2024. Euro area longer-term risk-free rates increased slightly in the review period, after falling in the days following the December Governing Council meeting and returning to their previous levels in the first weeks of 2024. The euro area ten-year nominal risk-free rate, for instance, decreased to 2.2% at the end of December before rebounding to around 2.5%, ending the review period with an overall increase of 16 basis points.

Long-term sovereign bond yields moved broadly in line with risk-free rates amid overall stable sovereign spreads (Chart 14). On 24 January the euro area GDP-weighted average ten-year sovereign bond yield stood at around 2.9%, around 19 basis points above its level at the beginning of the review period. Sovereign spread movements across euro area jurisdictions were closely contained throughout the review period, and the announcement at the December 2023 meeting to start gradually reducing PEPP reinvestments by mid-2024 did not appear to leave a notable mark. The increase in euro area long-term rates followed similar dynamics globally: the ten-year US sovereign bond yield increased by 26 basis points to stand at 4.2%, and the UK sovereign bond yield rose by 23 basis points to 4.0%.

Corporate bond spreads were largely unchanged over the review period, with spreads in the high-yield segment narrowing. The spreads for investment-grade firms ended the review period broadly unchanged, while spreads in the high-yield segment were more volatile, narrowing by 34 basis points.

Euro area equity prices remained range bound as declines in earnings expectations were offset by a reduction in the equity risk premium. Broad stock market indices in the euro area were largely unchanged over the review period, amid declining earnings expectations, whereas they increased by 2.7% in the United States. Equity price losses in the euro area were concentrated in the non-financial sector, with interest rate-sensitive sectors, such as technology and real estate, underperforming, while the financial sector continued to outperform the broad index. Overall, the equity prices of euro area non-financial corporations decreased by around 0.9%, while euro area banks’ equity prices and other euro area financials increased by 2.4% and 3.1% respectively. In the United States, equity prices increased by 3.1% for non-financial corporations and were broadly unchanged for banks.

In foreign exchange markets, the euro appreciated slightly in trade-weighted terms (Chart 15). The nominal effective exchange rate of the euro – as measured against the currencies of 41 of the euro area’s most important trading partners – appreciated by 0.4% over the review period. Expected monetary policy developments remained a major driver of exchange rate fluctuations and generated some volatility. That said, the euro was fairly stable against the US dollar, depreciating by only 0.1% as expectations for lower US rates were partly dialled back from the start of the year following the Federal Open Market Committee meeting in December 2023. In terms of bilateral exchange rate movements against other major currencies, the euro appreciated against the Turkish lira (by 3.9%) and the Japanese yen (by 3.7%), while it depreciated against the Swiss franc (by 0.8%) and the Pound sterling (by 0.5%).

Banks reported a further net tightening of credit standards for loans to households in the fourth quarter of 2023, which was small for housing loans and more pronounced for consumer credit. Risk perceptions were a major driver of the tightening of credit standards in both categories, with banks’ lower risk tolerance also driving the tightening of credit standards for consumer credit. While the slight tightening in the housing loan segment was driven by smaller euro area countries, credit standards for consumer credit tightened across the four largest euro area economies. For both loan categories, the net tightening was lower than in the third quarter, in line with banks’ expectations. For the first quarter of 2024, euro area banks’ expectations point to a pick-up in the net tightening of credit standards for housing loans, while for consumer credit they point to a net tightening similar to that reported for the last quarter of 2023.

Demand for loans by firms and households continued to decrease substantially in the fourth quarter of 2023, albeit less steeply than in the previous quarter. The drop in demand for loans to firms was due mainly to higher interest rates and lower fixed investment, consistent with the strong net decrease in demand for long-term loans. For housing loans and consumer credit, the decrease was driven by higher interest rates and low consumer confidence, with housing market prospects also exerting substantial downward pressure on demand for housing loans. Banks also reported a further net increase in the share of rejected loan applications for loans to firms and for housing loans. For the first quarter of 2024, banks expect a small net increase in demand for loans to firms (for the first time since the second quarter of 2022) and rising housing loan demand (for the first time since the first quarter of 2022), but a further decrease in consumer credit demand.

Weakness in bank lending to firms and households continued in November 2023, reflecting the strong pass-through of policy tightening to bank lending rates, together with lower loan demand and tighter credit standards. Reflecting a large monthly flow, annual growth in loans to NFCs rebounded slightly to stand at 0.0% in November, up from ‑0.3% in October (Chart 20, panel a), amid considerable heterogeneity across countries and maturities. Overall, the stagnation in loan demand is explained by high borrowing rates and associated spending plan cuts. Moreover, loan supply also plays a role, as suggested by the moderate further tightening of credit standards in the fourth quarter of 2023. The annual growth rate of loans to households edged down to 0.5% in November, after 0.6% in October (Chart 20, panel b), amid negative housing market prospects, somewhat tighter credit standards and higher lending rates. The decline was driven mainly by housing loans and loans to sole proprietors (i.e. unincorporated small businesses), while consumer loans remained more resilient, despite a further tightening of credit standards and low consumer confidence.

The discretionary fiscal measures to support households and companies in response to the energy price and high inflation shocks are projected to largely wind down in the coming years. They are estimated to amount to 1.3% of GDP in 2023, down from 1.8% in 2022, and to remain below 0.5% per annum over the 2024-26 projection horizon (Chart A). Specifically, about two-thirds of support measures in place in 2023 are expected to expire in 2024, and another 20% in 2025. The remaining measures are projected to stay in place in 2026. As regards the type of measures, in 2023 almost half were subsidies. Of these, more than half related to the energy price caps in Germany, France and the Netherlands. The share of subsidies in total energy and inflation support measures is expected to fall significantly in 2024 and to be negligible as of 2025.