Summary of the June Monthly Report

Outlook for the German economy –macroeconomic projections for 2015 and 2016 and an outlook for 2017

The German economy has recovered more quickly than expected from the cyclical lull in the middle of last year and has returned to a growth path that is underpinned by domestic and foreign demand. Domestic economic activity is benefitting from the favourable labour market situation and the substantial wage increases. Although foreign trade is currently being hampered by dampening global dynamics, it is simultaneously being buoyed by the euro's depreciation and the strengthening economic recovery in the euro area. Moreover, the world economy is likely to regain momentum.

In this setting, growth of 1.7% in Germany’s real gross domestic product (GDP) this year could be followed by a rise of 1.8% in 2016 and 1.5% in 2017. In calendar-adjusted terms, this would be equivalent to expansion rates of 1.5% in 2015 and 1.7% in both 2016 and 2017. As the expected increases are above the estimated potential growth rate of 1.2% per year, aggregate capacity utilisation should rise markedly and considerably exceed normal levels by the end of the forecast horizon. This means that labour market reserves will be mobilised and wages will rise more strongly in the medium term.

Against this backdrop, general government is set to continue posting surpluses of around 0.5% of GDP. However, the economic upturn and the ongoing decline in interest expenditure are masking the generally expansionary stance of fiscal policy. Consumer price inflation is likely to accelerate, driven initially by the effect of the euro's depreciation against other major currencies, while the upward pressure on domestic costs should increasingly make itself felt later on. As measured by the Harmonised Index of Consumer Prices (HICP), inflation could rise from 0.5% this year to 1.8% next year and 2.2% in 2017. Excluding energy, HICP inflation would climb from 1.2% in 2015 to 2.2% in 2017.

Compared with the December 2014 projection, expectations for economic growth for the current year in particular have been raised significantly, while the projection for inflation has been pared back considerably. Key factors included the plummeting crude oil prices and the depreciation of the euro. Crude oil prices are expected to rise only slightly, and exchange rates to remain unchanged, over the forecast period. If the euro were to appreciate strongly, this would produce downside risks to the economy. Further external risks exist as a result both of the vulnerabilities of several emerging market economies (EMEs) and of geopolitical tensions. The danger that the economic recovery in the euro area might suffer a setback has not yet been banished. On the domestic front, increasingly tight labour markets represent a supply-side risk to economic growth. This could also be reflected in accelerated upward pressure on prices.

Inflation expectations: newer instruments, current developments and key determinants

Expectations about future developments in inflation are a key indicator with which to assess the effectiveness and credibility of monetary policy. Inflation expectations can be derived from survey data or from financial market instruments, such as inflation-indexed bonds or inflation swaps. Expectations derived in this way are, however, generally point forecasts.

Inflation options – a relatively new type of financial market instrument – enable market participants to go one step further and to derive risk-neutral or preference-weighted probability distributions. These distributions allow statements to be made regarding the range of dispersion used by market participants for the point forecasts, whether they symmetrically estimate the risk of missing the mean and how they rate the likelihood of exceptionally high or low inflation rates occurring.

An event study which looks at the period between 2009 and 2014 shows that the probabilities of occurrence for future inflation rates responded heterogeneously to macroeconomic data and monetary policy announcements over time. It can also be observed against the backdrop of the intensification of the sovereign debt crisis that market players' uncertainty regarding future inflation developments in the euro area has increased.

Last year saw a marked decline in, above all, long-term market-based inflation expectations, but they rebounded somewhat after the turn of the year, not just in the euro area but also in the United States and in the United Kingdom. In this context, reference is often made to the stronger influence of oil prices. However, it is still too early to say with any degree of certainty whether this will continue to have an impact over the longer term. Against the backdrop of the major importance of firmly anchored inflation expectations, the lower expected value, especially in the financial market data, and the wider fluctuation margin of inflation expectations should, at any rate, be meticulously analysed.

Marketable financial instruments of banks and their role as collateral in the Eurosystem

The launch of monetary union saw a narrowing of the gap between banks' market-based funding and traditional deposit business, a development that was buoyed by measures designed to promote the financial markets as well as by the process of European integration. The Eurosystem's willingness to accept many of banks' marketable financial instruments as collateral for its refinancing operations is a hallmark of a monetary policy operating framework based on broad collateral eligibility and a wide access policy offering a large number of banks access to refinancing facilities in an effort to promote equal treatment among counterparties in the euro area.

The refinancing operations conducted by the Eurosystem are essentially large-scale, short-term credit operations for which banks need to hold a sufficient stock of eligible assets as collateral. The Eurosystem's broad collateral eligibility policy sets it clearly apart from many other central banks.

Since the onset of the financial and sovereign debt crisis more than seven years ago, the Eurosystem has rolled out a wide variety of measures to support the markets for bank financial instruments. Its aim has been to avert severe impasses in the availability of collateral and their destabilising effects on the markets while simultaneously keeping its own risk control measures at a sufficiently elevated level. But no matter how much the Eurosystem influences the design and use of banks' marketable financial instruments, there is no getting around the need for adjustments within the banking sector. Going forward, banks might see less of a need, at least for now, to hold a stock of eligible assets for regular refinancing operations given that the Eurosystem has purchased larger and longer-dated stocks of securities as part of the expanded asset purchase programme and thus provided an abundant supply of liquidity through this channel. By contrast, the regulatory playing field which has emerged during the course of the crisis looks set to exert a stronger influence over banks' marketable financial instruments.