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Central Bank of Malta Quarterly Review – Third Issue 2013

The Central Bank of Malta has published the third issue of its Quarterly Review for 2013, which analyses economic and financial developments in Malta and abroad during the second quarter of 2013 and highlights additional developments in subsequent months.

The Review carries an article on inflation differentials between Malta and the euro area. It also includes a box comparing wealth, financing and consumption patterns of Maltese households with those of the euro area. Another box reports on an analysis of households’ sensitivity to house prices and interest rate shocks. The relationship between real economic activity and the labour market in Malta is addressed in another box. The Review also carries the address delivered by the Governor during the latest Annual Dinner of the Institute of Financial Services – Malta.

The Review commences its analysis by reporting on monetary policy decisions taken by the Governing Council of the European Central Bank (ECB). In May, the Council lowered the interest rate on the main refinancing operations (MRO) of the Eurosystem by 25 basis points to 0.50%, while that on the marginal lending facility was reduced by 50 basis points to 1.00%. The rate on the deposit facility was left unchanged at 0.00%. In November, the Council lowered the interest rate on the MRO by another 25 basis points to a new historical low of 0.25%. Meanwhile, the interest rate on the marginal lending facility was cut by 25 basis points to 0.75%, while that on the deposit facility was left unchanged at 0.00%. These decisions reflected expectations of low underlying price pressures over the medium term, ongoing weakness in the euro area economy and subdued money and credit dynamics.

The Eurosystem continued to implement non-standard monetary measures aimed at supporting the monetary policy transmission mechanism. Notably, in July it introduced forward guidance, with the Governing Council announcing that it expected key interest rates to remain unchanged or lower for an extended period of time.

The Review notes that developments in the world’s major economies were mixed in the second quarter of 2013. The pace of activity in advanced economies gained momentum, whereas growth in the main emerging economies slowed down. Inflationary pressures remained moderate in most large economies.

During the second quarter of 2013, economic activity in the euro area recovered, with Gross Domestic Product (GDP) growth turning positive after six quarters of contraction. Real GDP expanded by 0.3% on the preceding quarter, with both domestic demand and net exports contributing positively to growth. The euro area economy is estimated to have expanded by 0.1% in the third quarter.

The annual inflation rate based on the Harmonised Index of Consumer Prices (HICP) in the euro area fell further, reaching 0.7% by October, as a result of a broad-based easing in price pressures.

ECB staff macroeconomic projections for the euro area, published in September, show that GDP is expected to contract by 0.4% in 2013 before expanding by 1.0% in 2014. The average annual rate of inflation is projected to decline from 2.5% in 2012 to 1.5% in 2013 and to 1.3% in 2014.

Turning to the Maltese economy, the Review observes that output continued to expand in the second quarter, with the annual real GDP growth rate accelerating to 3.6% from 1.8% in the preceding quarter. This reflected higher net exports, as imports fell more strongly than exports, whereas domestic demand contracted. The latter reflected declines in private consumption, investment and inventories.

The Review also carries a supplement on developments in GDP in the third quarter of 2013, based on data which became available after the Review was prepared. Economic activity slowed down, with the annual rate of GDP growth moderating to 1.9%, after having expanded by a revised 3.3% in the previous quarter.

The annual rate of HICP inflation decelerated to 0.6% in June from 1.4% in March. This was primarily spurred by movements in the prices of services, energy and non-energy industrial goods, where the inflation rate turned negative. Annual HICP inflation remained unchanged at 0.6% in September.

Employment rose further during the second quarter of 2013, with the Labour Force Survey showing an annual increase of 3.0%, following a rise of 1.7% in the previous quarter. Nevertheless, with the labour supply expanding more strongly, the unemployment rate rose to 6.7%, compared with 6.5% a year earlier.

During the second quarter of 2013, both the nominal and real harmonised competitiveness indicator (HCI) increased on a year earlier, by 3.1% and 1.6%, respectively. These movements reflected the appreciation of the euro against the US dollar and the pound sterling, which were partly offset by a narrower inflation differentials against trading partners. The annual rate of change of the nominal HCI reached 3.5% in September, while that of the real HCI stood at 2.6%. Between April and June, Malta’s unit labour cost index, measured as a four-quarter moving average, was 3.2% higher in annual terms, following a 3.0% increase in the first three months of the year.

In the external sector, during the second quarter of 2013 the current account of the balance of payments registered a larger surplus compared with the same period of 2012. This resulted from a smaller merchandise trade deficit and higher net inflows on services, which outweighed higher net outflows in the income account and lower net inflows on current transfers. The current account balance, expressed as a four-quarter moving sum, stood at 2.0% of GDP in the year to June 2013, down by half a percentage point over the comparable period of 2012.

With regard to the financial sector, the Review notes that the total assets of the core domestic banks in Malta remained broadly stable during the second and third quarters of 2013, with deposits remaining their main source of funding. Deposits held by Maltese residents accelerated during the second and third quarters, whereas credit granted to them slowed down considerably, due to reduced lending to the corporate sector.

In the domestic financial markets, yields on three-month Treasury bills declined in both the primary and the secondary market in the second quarter. Yields on five-year and ten-year government bonds also fell. The downward trend in yields persisted in the third quarter. During the second quarter, the MSE share index rose for the fifth consecutive quarter, increasing by 2.9% from its end-March level. Over the following quarter the index increased marginally.

In its analysis of the fiscal situation, the Review observes that in the second quarter of 2013, the general government deficit widened slightly on a year earlier, as expenditure outpaced revenue. Measured as a four-quarter moving sum, the deficit stood at 3.7% of GDP at the end of June, 0.1 percentage point below its end-March level. The general government debt rose to 75.8% of GDP in June from 75.0% three months earlier. However, the deficit on the Consolidated Fund narrowed over the first nine months of 2013, as revenue rose faster than expenditure.

The Review also presents the Bank’s latest economic projections, which were completed in November 2013. Real GDP growth is foreseen to accelerate to 1.8% in 2013 and 2.0% in 2014. In 2013, economic growth is expected to be driven by net exports. Domestic demand is projected to drive expansion in 2014, as private consumption accelerates and investment begins to recover. HICP inflation is expected to fall to 1.0% in 2013. It is then set to rise to 1.4% in 2014, as a result of faster growth in services prices and higher indirect taxes. Risks to the growth projections are on the downside for 2013, but broadly balanced for 2014. Risks to the inflation outlook are slightly on the downside for 2014.

From a policy perspective, the Bank continues to emphasise that the Government should ensure that it achieves its budgetary targets and thus correct the excessive deficit as soon as possible. Additional fiscal consolidation would help in achieving the medium-term objective of a balanced budget and attain a sustainable reduction in the debt ratio.

Regarding the financial system, the Bank notes that banks in Malta remain resilient, reporting adequate capitalisation, liquidity and profitability levels. Thus, they are in a good position to support economic activity through the provision of credit. Margins between bank lending rates and deposit rates are high relative to those in the stronger euro area countries, suggesting that bank lending rates could be lowered. This would facilitate access to finance for Maltese firms thereby supporting investment, competitiveness and growth. It would also ensure that the accommodative monetary policy of the Eurosystem also benefits the domestic economy.

The third issue of the Quarterly Review for 2013 is available on the website of the Central Bank of Malta at www.centralbankmalta.org.