12/09/2014

Central Bank of Malta Quarterly Review – Second Issue 2014

The Central Bank of Malta has published the second issue of its Quarterly Review for 2014, which analyses economic and financial developments in Malta and abroad during the first quarter of 2014 and highlights further developments in subsequent months. The Review also carries three brief analytical reports on developments in Malta's structural unemployment, the cyclically adjusted fiscal balance and communicating uncertainty around inflation projections.

The Review notes that the European Central Bank (ECB) eased the monetary policy stance during the period reviewed on the basis of the persistently low inflation environment, weak growth momentum in the euro area and subdued money and credit dynamics.

In June the Governing Council of the ECB lowered the interest rate on the main refinancing operations (MRO) by 10 basis points to 0.15%. The rates on the marginal lending facility and the deposit facility were also reduced to 0.40% and -0.10%, respectively, with the latter moving into negative territory for the first time.

Meanwhile, the Eurosystem further enhanced its package of non-standard measures through the introduction of four-year targeted longer-term refinancing operations (TLTROs) at fixed interest rates.

In September, the Governing Council of the ECB announced further rate cuts, lowering all three key interest rates by 10 basis points and thus bringing the MRO rate down to 0.05%. It also announced that the Eurosystem will begin to buy asset-backed securities and covered bonds issued by the non-financial private sector, to support the provision of liquidity to the economy.

The Review notes that in the first quarter of 2014, overall growth in the global economy remained subdued. The United Kingdom and Japan reported solid expansion, whereas the United States' economy contracted in quarter-on-quarter terms. In emerging economies, activity generally weakened, led by a slowdown in China. Meanwhile, global inflationary pressures remained moderate.

The euro area economy continued to recover slowly during the first quarter of 2014, with real gross domestic product (GDP) rising by 0.2% quarter-on-quarter, driven by domestic demand. In the second quarter, however, Eurostat's preliminary estimate indicated that real GDP growth was stable compared with the first three months of the year.

In terms of inflation, the annual rate based on the Harmonised Index of Consumer Prices (HICP) dropped to 0.5% in March, from 0.8% three months earlier. This mainly reflected developments in food and energy prices. Price pressures remained subdued in the second quarter of 2014, with the annual rate remaining at 0.5% in June.

According to the Eurosystem's macroeconomic projections published in June, real GDP growth in the euro area was expected to rise to 1.0% in 2014 and pick up further to 1.7% and 1.8% in 2015 and 2016, respectively. The annual inflation rate was projected to weaken to 0.7% in 2014, before rising to 1.1% in 2015 and 1.4% in 2016.

In Malta, economic activity grew at a faster pace during the first quarter of 2014, with real GDP expanding by 3.5% in annual terms. Growth was mainly driven by domestic demand, particularly investment, while net exports contributed only marginally.

The Review carries further information on developments in GDP in the second quarter of 2014. Thus, while economic activity in this period remained strong, the annual rate of GDP growth moderated to 2.9%.

Price pressures in Malta picked up further, but remained low. The annual HICP inflation rate rose to 1.4% in March, from 1.0% in December, reflecting developments in the prices of services, energy and non-energy industrial goods. By June, inflation slowed down to 0.7%, partly under the impact of lower electricity tariffs introduced in April.

Employment continued to rise in the first quarter of 2014, with the Labour Force Survey (LFS) showing an increase of 1.9% on a year earlier, following a 2.8% expansion in the previous quarter. The LFS unemployment rate stood at 6.0%, unchanged compared with a year earlier, but lower than in the previous quarter.

In the external sector, the current account deficit of the balance of payments narrowed over the first quarter compared with the same period a year earlier. This resulted from lower net outflows on the income account, although a higher surplus on the services component also contributed. Together, these developments outweighed a widening in the merchandise trade gap and lower net inward current transfers. In the year to March 2014, the current account registered a surplus equivalent to 1.6% of GDP.

During the second quarter of 2014, monetary developments were characterised by a further increase in residents' deposits with local banks. These were driven by overnight deposits and deposits with an agreed maturity of up to two years. Meanwhile, credit granted to residents, which had slowed down in the previous quarter, rose at a faster pace.

In the domestic financial markets, yields on three-month Treasury bills fell, as did those on five-year and ten-year government bonds. During the second quarter, the Malta Stock Exchange share index continued to lose ground, shedding 3.7%.

On the fiscal front, the Review observes that in the first quarter of 2014, the general government deficit widened on a year earlier, as expenditure outpaced revenue. Measured as a four-quarter moving sum, the deficit increased to 3.1% of GDP at the end of March. Concurrently, the general government debt rose to 75.3% of GDP from 74.4% a year earlier.

On policy issues, the Review notes that fiscal policy remains oriented towards meeting the budgetary targets for this year and ensuring compliance with the relevant EU Council Recommendations under the Excessive Deficit Procedure. In this regard, the recent approval by Parliament of the Fiscal Responsibility Act is a welcome development, as it strengthens fiscal discipline.

On financial stability, the Review highlights the satisfactory performance of the Maltese financial system in the first quarter of 2014, as reflected in the strong capital adequacy ratios of core domestic banks, ample liquidity levels and the continued growth in residents' deposits. Nonetheless, the Review notes that further efforts are required to diversify funding sources, increase provisions and strengthen capital bases. There may also be scope for increased lending to the private sector, especially given the banks' relatively healthy position and the availability of funding at favourable terms from the Eurosystem.

The second issue of the Quarterly Review for 2014 is available on the website of the Central Bank of Malta at www.centralbankmalta.org.

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