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ECB Monthly Bulletin Editorial for July (Text)

The following is the text of the European Central Bank’s July monthly bulletin:

Based on its regular economic and monetary analyses, the Governing Council decided at its meeting on 5 July to cut the key ECB interest rates by 25 basis points. Inflationary pressure over the policy-relevant horizon has been dampened further as some of the previously identified downside risks to the euro area growth outlook have materialised. Consistent with this picture, the underlying pace of monetary expansion remains subdued. Inflation expectations for the euro area economy continue to be firmly anchored in line with the Governing Council’s aim of maintaining inflation rates below, but close to, 2% over the medium term. At the same time, economic growth in the euro area continues to remain weak, with heightened uncertainty weighing on confidence and sentiment.

The Eurosystem has implemented both standard and non-standard monetary policy measures. This combination of measures has supported the transmission of monetary policy. All the non-standard monetary policy measures are temporary in nature and the Eurosystem maintains its full capacity to ensure medium-term price stability by acting in a firm and timely manner. In this respect, on 22 June 2012 the Governing Council decided on further measures to increase collateral availability for counterparties.

As regards the economic analysis, on a quarterly basis, euro area real GDP growth was flat in the first quarter of 2012, following a decline of 0.3% in the previous quarter. Indicators for the second quarter of 2012 point to a renewed weakening of economic growth and heightened uncertainty. Looking beyond the short term the Governing Council expects the euro area economy to recover gradually, although with momentum dampened by a number of factors. In particular, tensions in some euro area sovereign debt markets and their impact on credit conditions, the process of balance sheet adjustment in the financial and non-financial sectors and high unemployment are expected to weigh on the underlying growth momentum.

The risks surrounding the economic outlook for the euro area continue to be on the downside. They relate, in particular, to a renewed increase in the tensions in several euro area financial markets and their potential spillover to the euro area real economy. Downside risks also relate to possibly renewed increases in energy prices over the medium term.

Euro area annual HICP inflation was 2.4% in June 2012, according to Eurostat’s flash estimate, unchanged from the previous month. On the basis of current futures prices for oil, inflation rates should decline further in the course of 2012 and be again below 2% in 2013. Over the policy-relevant horizon, in an environment of modest growth in the euro area and well-anchored long-term inflation expectations, underlying price pressures should remain moderate.

Taking into account the Governing Council’s decisions of 5 July, risks to the outlook for price developments continue to be broadly balanced over the medium term. The main downside risks relate to the impact of weaker than expected growth in the euro area. Upside risks pertain to further increases in indirect taxes, owing to the need for fiscal consolidation, and higher than expected energy prices over the medium term.

Turning to the monetary analysis, the underlying pace of monetary expansion has remained subdued, with short-term developments displaying some volatility. The increase in the annual growth rate of M3 to 2.9% in May, up from 2.5% in April and close to the 3.0% observed in March, mainly reflected a reversal of the outflows in April from overnight deposits belonging to non-monetary financial intermediaries (particularly investment funds). In addition to an increased preference for deposits with shorter maturities, these factors have also shaped M1developments, with the annual growth rate increasing from 1.8% in April to 3.3%in May.

The annual growth rate of loans to the private sector (adjusted for loan sales and securitisation) declined to 0.4% in May (from 0.8% in April). Annual growth rates for loans to both non-financial corporations and households (adjusted for loan sales and securitisation) also decreased in May, to 0.2% and 1.3% respectively, with negative monthly loan flows to non-financial corporations. To a large extent, subdued loan growth reflects the current cyclical situation, heightened risk aversion, and the ongoing adjustment in the balance sheets of households and enterprises which weigh on credit demand.

Looking ahead, it is essential for banks to continue to strengthen their resilience where it is needed. The soundness of banks’ balance sheets will be a key factor in facilitating both an appropriate provision of credit to the economy and the normalisation of all funding channels.

To sum up, taking into account the Governing Council’s decisions of 5 July, the economic analysis indicates that price developments should remain in line with price stability over the medium term. A cross-check with the signals from the monetary analysis confirms this picture.

With regard to other policies, the Governing Council welcomes the European Council conclusions of 29 June 2012 to take action to address financial market tensions, restore confidence and revive growth. The Governing Council agrees that Economic and Monetary Union needs to be put on a more solid basis for the future and that sustainable growth, sound public finances and structural reforms to boost competitiveness remain key economic priorities. The Governing Council welcomes the decision to develop a specific and time-bound road map for the achievement of a genuine Economic and Monetary Union. Furthermore, the Governing Council welcomes the euro area summit initiative towards a single supervisory mechanism, the possibility - with appropriate conditionality - to recapitalise banks directly, and the use of existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets. Finally, the ECB is ready to serve as an agent to the EFSF/ESM in conducting market operations. This issue of the Monthly Bulletin contains two articles. The first article analyses the interactions between fiscal and monetary policy in EMU and identifies the elements for an improved policy framework. The second article reviews the evolution of longer-term inflation expectations for the euro area.

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