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MNI Connect Video Conference
1) Inflation remains high and risks of second-round effects on wages and de-anchoring of inflation expectations persist. Monetary policy will need to go beyond neutral rates and hikes will become more cautious to return inflation to 2% in the medium term. 2) Industrial production figures hide disruption in energy-intensive industries, whose outlook remains weak. Inflation has increased broadly across countries due to high energy and food prices, and core inflation is also picking up. 3) Recession risks are rising as geopolitical uncertainty and the war in Ukraine push the euro area closer to contraction in 2023, according to ECB projections. Monetary policy normalization will continue in steps to withdraw accommodation.
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- 1. MNI Connect Video Conference Governorof Latvijas Banka Member of the ECB's Governing Council Mārtiņš Kazāks, PhD
- 2. Inflation higher forlonger, risks of second-round effects and de-anchoring of inflation expectations remain. Monetary policy: decisions data driven, to go beyond the levels of neutral rate, hikes to become more cautious, all instruments to be aligned to reach 2% in medium term, avoid fiscal and financial dominance. Main takeaways Fiscal policy to guard against short-term downside risks to growth. Fiscal support should be timely, temporary, targeted and not to add to inflation risks. Russia`s war against Ukraine, global energy crises and ensuing supply chain problems add to uncertainty: downside risks to growth and upside risks to inflation; recession risks.. Effective policy risk: monetary, fiscal, structural, macroprudential. Energy is the key risk: longer-lasting impact and fear for competitiveness of energy intensive industries.
- 3. Economic Policy Uncertaintyindex 0 100 200 300 400 500 600 700 800 900 1000 0 50 100 150 200 250 300 350 400 2006 2008 2010 2012 2014 2016 2018 2020 2022 Europe United States China (rhs) Conference Board Leading economic index (%; annual growth rate) 0 -40 -30 -20 -10 0 10 20 30 40 2006 2008 2010 2012 2014 2016 2018 2020 2022 EZ recessions US recessions Euro zone US China UK 3 Source: Economic Policy Uncertainty, Conference Board, LB calculations (latest obs. 10/22). Heading into a slowdown amidst rising uncertainty and risk of recession Global financial crisis Shift in US trade policy; withdrawal from Iran deal; instability in EM economies; Covid-19 Russia-Ukraine war, China lockdowns, energy crisis Start of the European sovereign debt crisis Brexit vote; US elections
- 4. EA industrial production(100 = 01/22) 90 92 94 96 98 100 102 104 01/21 04/21 07/21 10/21 01/22 04/22 07/22 Total production Energy-intensive industries Industrial confidence indicator (balance of answers) -30 -20 -10 0 10 20 30 01/21 04/21 07/21 10/21 01/22 04/22 07/22 10/22 Paper and paper products Coke and refined petroleum products Chemicals and chemical products Other non-metallic mineral products Basic metals Total industry 4 Sources: Eurostat and LB calculations. Last obs. for IP – september, 2022. Industrial production figures are hiding disruption of energy-intensive industries and their weak outlook
- 5. HICP, HICP ex.food and energy (y/y, %) -2 0 2 4 6 8 10 12 01/08 09/09 05/11 01/13 09/14 05/16 01/18 09/19 05/21 Headline and core inflation by EA country (%; y-o-y, October 2022) 7.1 7.3 7.4 8.4 8.6 8.8 9.4 9.5 10.3 10.6 10.6 11.5 11.6 12.6 13.1 14.5 16.8 21.7 22.1.0 22.5 0 5 10 15 20 25 FR ES MT FI CY LU IE EL SI PT EA AT DE IT BE SK NL LV LT EE Core inflation Headline inflation 5 Source: Eurostat. Inflation has increased broadly across countries
- 6. Distribution of HICP(295 items; latest data for October, 2022) 0 10 20 30 40 50 60 70 80 90 100 -10 -5 0 5 10 15 20 25 30 01/18 04/18 07/18 10/18 01/19 04/19 07/19 10/19 01/20 04/20 07/20 10/20 01/21 04/21 07/21 10/21 01/22 04/22 07/22 10/22 90% of items 75% of items 50% of items Headline inflation Above 2% RHS 6 Source: Eurostat. Inflation is broad based
- 7. HICP annual growthrate (%) by components (pp) -2 0 2 4 6 8 10 12 01/19 06/19 11/19 04/20 09/20 02/21 07/21 12/21 05/22 10/22 Food Non energy industrial goods Energy Services HICP inflation excluding energy and food (%) and decomposition (pp) 7 Source: Eurostat, Latvijas Banka's calculations, ECB. Last observation: October 2022, September for HICP core components. Energy and food price increases leading inflation surge, other sectors also picking up
- 8. US oil productionand crude oil price (USD; mbpd) 10 15 20 25 30 0 20 40 60 80 100 120 2019 2020 2021 2022 2023 Brent price Brent Futures US oil production (rhs) US Oil production forecast (rhs) TTF Natural gas price and Russian gas flows to Europe (euro; Gwh/d) 0 1000 2000 3000 4000 5000 6000 7000 0 50 100 150 200 250 300 350 2019 2020 2021 2022 2023 TTF Natural gas price Futures contracts Russian gas flow to Europe (rhs) 8 Source: EIA, Refinitiv. Global energy prices have declined from peak levels as recession fears mount
- 9. -40,000 -30,000 -20,000 -10,000 0 10,000 20,000 30,000 40,000 50,000 60,000 01/17 08/17 03/1810/18 05/19 12/19 07/20 02/21 09/21 04/22 Goods Services Primary income Secondary income Current account 9 Euro area current account balance, (EUR million, working day and seasonaly adjusted) Source: Eurostat. Trade balance reflects negative shocks. Weaker currency makes imports even more expensive.
- 10. Shipping Indexes (dailyfrequency) 0 2000 4000 6000 8000 10000 12000 2017 2018 2019 2020 2021 2022 FBX Global Container Index (USD) Baltic Exchange Dry Index (BDI) HARPEX Shipping Index CCFI Index SCFI Index Global Supply Chain Pressure Index (st. dev. from long-term average) -2 -1 0 1 2 3 4 5 01/19 06/19 11/19 04/20 09/20 02/21 07/21 12/21 05/22 10/22 10 Source: Refinitiv, Markit, Ifo Institute, New York FED. Global supply chain pressures, shipping and transportations logjams have significantly eased up, but risks remain
- 11. Consumer expectations survey(diffusion index) -60 -40 -20 0 20 40 60 80 100 01/20 05/20 09/20 01/21 05/21 09/21 01/22 05/22 09/22 EA countries EA Distribution of long–term (5 years ahead) inflation expectations in Survey of Professional Forecasters (percentage of respondents) 0 5 10 15 20 25 30 35 40 45 ≤ 1.5 1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 2.4 ≥ 2.5 Q2 2022 Q3 2022 Q4 2022 11 Source: European Commission, ECB. Last obs. October 2022. Risk of feeding higher-for-longer inflation into expectations; risk of de-anchoring
- 12. -6 -4 -2 0 2 4 6 8 2020Q1 2020Q3 2021Q12021Q3 2022Q1 2022Q3 q/q y/y Wage tracker 12 Compensation per employee, (q/q and y/y changes, %) seasonally and calendar adjusted) and wage tracker Indeed (y/y, %) Source: ECB, Bank of Ireland, Indeed. Wage growth surprisingly modest so far, however it is likely to accelerate
- 13. Scenarios for euroarea real GDP and inflation (annual percentage changes) 13 Source: ECB September 2022 MPE. Geopolitical uncertainty and Russia`s war is pushing the euro zone closer towards a contraction in 2023 -8 -6 -4 -2 0 2 4 6 2019 2020 2021 2022 2023 2024 Baseline scenario Downside scenario 0 1 2 3 4 5 6 7 8 9 2019 2020 2021 2022 2023 2024 Baseline scenario Downside scenario 2022 2023 2024 2022 2023 2024 Real GDP 3.1 0.9 1.9 2.8 -0.9 1.9 HICP inflation 8.1 5.5 2.3 8.4 6.9 2.7
- 14. -1 0 1 2 3 4 5 01/20 07/20 01/2107/21 01/22 07/22 IT PT ES FR NL DE Covid-19 PEPP 10Y government bond nominal yields (%) Government bond real rates (%) 14 Source: Bloomberg, Refinitiv, ECB. The rise in real yields adds to tightening of financial conditions -4 -3 -2 -1 0 1 2 3 01/14 01/16 01/18 01/20 01/22 Euro zone 2Y US 2Y Euro zone 10Y US 10Y
- 15. Monetary policy normalization in 3steps 15 ▪ Withdraw monetary accommodation by frontloading increases in policy rates. ▪ Thereafter smaller rate hikes as risks become two-sided. ▪ If needed to achieve our policy aim of price stability, proceed with rate hikes above the neutral. ▪ In parallel with tightening of policy rates, align all instruments, including balance sheet.
- 16. 16 ECB Deposit facilityand €STR rate (%) Source: Refinitiv. Progress in withdrawing monetary policy accommodation; further steps should follow ▪ The fastest increase of our interest rates by 200 basis points ▪ Changes in the terms and conditions of the third series of targeted longer- term refinancing operations (TLTRO III) ▪ Alignment of the remuneration of minimum reserves with money market conditions -1.0 -0.5 0.0 0.5 1.0 1.5 01/20 07/20 01/21 07/21 01/22 07/22 €STR Deposit facility rate
- 17. 17 Source: ECB,NCBs estimates -2 -1 0 1 2 3 4 5 6 7 -2 -1 0 1 2 3 4 5 6 7 1999 2002 2005 2008 2011 2014 2017 2020 Data: SMA Data: OIS Data: Consensus (Euribor) Data: Consensus (ESTR) Term structure-based: GS+JSZ Term structure-based: GS Term structure-based: Ajevskis Term structure-based: BGL Semi-structural: Proxy Semi-structural: BM Semi-structural: HLW Semi-structural: HLW (pi*, 2y ahead SPF) Semi-structural: HLW (pi*, 5y ahead SPF) Econometric estimates: Jarocinski DSGE: GN Econometric estimates of euro area r* (percentages per annum) The exact level of «neutral» rate is unknown. But clearly at the current level of rates policy still accomodative. This explains significant increases of rates in the past, and why more rate hikes are underway.
- 18. €STR SWAP impliedrates (as of 22 Nov) for the forthcoming ECB meetings (%) -0.8 -0.3 0.2 0.7 1.2 1.7 2.2 2.7 3.2 04/21 07/21 10/21 01/22 04/22 07/22 10/22 June 23 GovC Sep 23 GovC Dec 23 GovC 3M Euribor futures curve (% p.a.) -0.5 0 0.5 1 1.5 2 2.5 3 3.5 06/22 06/23 06/24 06/25 06/26 06/27 06/28 21.11.2022 Last GovC (10.27.2022) Day before Sep. GovC (07.09.2022) Day before June GovC (08.06.2022) 18 Source: Bloomberg. Market expectations in line with policy rates above r*, but the exact level will depend on the changes in inflation outlook
- 19. - 1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 1Q 20 2Q 20 3Q 20 4Q 20 1Q 21 2Q 21 3Q 21 4Q 21 1Q 22 2Q 22 3Q 22 4Q 22 1Q 23 2Q 23 3Q 23 4Q 23 1Q 24 2Q 24 3Q 24 4Q 24 HICP HICPex energy and food 19 Source: ECB September 2022 MPE. Euro area HICP, actual data and projections for 2023-2024 (annual % changes) One way of monitoring inflation outlook is by looking at our projections. But our models, and, of course, also projections, are not perfect. Continue to rise rates until they become consistent with the 2% target.
- 20. Bloomberg 1-year aheadrecession probability index 0 10 20 30 40 50 60 70 80 90 100 06/12 06/14 06/16 06/18 06/20 06/22 US EA Swap implied inflation expectations in EA (% and pp) 0% 1% 2% 3% 4% 01/08 01/11 01/14 01/17 01/20 1y1 5y5y ECB target 20 Source: Bloomberg, Eurostat, Bank of Ireland, Indeed, Latvijas Banka's calculations. Analysis needs to be complemented by a broader set of indicators (and judgement!) Compensation per employee, (q/q and y/y changes, %) and wage tracker Indeed (y/y, %) -6 -4 -2 0 2 4 6 8 2020Q1 2020Q3 2021Q1 2021Q3 2022Q1 2022Q3 q/q y/y Wage tracker
- 21. Eurosystem balance sheet(% of GDP), excess liquidity (% of GDP) Excess liquidity and the €STR-DFR spread (x-axis: EUR tn; y-axis: basis points) 21 Source: Bloomberg, Eurostat, ECB. Further withdrawal of excess liquidity should follow with a gradual phasing out of APP reinvestments and followed by PEPP reinvestments 0 10 20 30 40 50 60 70 80 01/15 01/16 01/17 01/18 01/19 01/20 01/21 01/22 ECB balance sheet as % of GDP Excess liquidity as % of GDP
- 22. 22 Output gap vsstructural balance (% of GDP) Source: European Commission, ECB. Monetary policy is not the only game in town. Fiscal support must be timely, temporary, and targeted in order not to add to inflation risks. Structural and macroprudential policies should promote macroeconomic stability and long-term growth. -6 -5 -4 -3 -2 -1 0 1 2 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Structural deficit Output gap
- 23.