June issue of Monthly Report published

The German economy has recovered more quickly than expected from the cyclical lull in the middle of last year. In their most recent Monthly Report, Bundesbank economists write that the economy has returned to a growth path underpinned by domestic and foreign demand. They believe that domestic economic activity is benefiting 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, Bundesbank economists state that the world economy is likely to regain momentum.

In this setting, Bundesbank economists estimate that 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.

Surplus in public finances remains

As Bundesbank economists see it, general government is set to continue posting surpluses of around 0,5% of GDP against this backdrop. However, the economic upturn and the ongoing decline in interest expenditure are thought to mask 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), Bundesbank economists estimate that 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, the Bundesbank has significantly raised its expectations for economic growth for the current year in particular, while the projection for inflation has been pared back considerably. Key factors included the plummeting crude oil prices and the depreciation of the euro.

New instruments for measuring inflation expectations

A further topic addressed in the Monthly Report is expectations about future developments in inflation, which are a key indicator in assessing 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. Bundesbank economists write that expectations determined in this way are often point forecasts and go on to outline inflation options – a relatively new type of financial market instrument which enable market participants to go one step further and derive risk-neutral or preference-weighted probability distributions.

Banks' marketable financial instruments

Furthermore, the Monthly Report focuses on the marketable financial instruments of banks. The launch of monetary union enabled 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 Monthly Report states. Bundesbank economists see the Eurosystem's willingness to accept many of banks' marketable financial instruments as collateral for its refinancing operations as 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.

They also believe that 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 clearly sets it apart from many other central banks, say Bundesbank economists.

Growing impact of regulation

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, emphasize the Bundesbank economists.