Annual Report 2017 Contents

Annual Report 2017 Contents The year at a glance 4 The year in figures 6 The ECB’s policies and activities in the economic and financial environment of 2017 8 1 The euro area’s economic recovery was supported by tailwinds and monetary policy 8 1.1 Global economic growth gained momentum 8 1.2 Euro area macroeconomic, fiscal and structural developments 12 Box 1 Structural policies in the euro area labour market 21 Box 2 Understanding the subdued inflation dynamics 23 Box 3 What drives structural reform implementation? 26 1.3 Financial and monetary developments 28 Box 4 The structural dimension of the financing of non-financial corporations and households in the euro area 35 2 Monetary policy: patience, persistence and prudence 39 2.1 The monetary policy stance: very substantial accommodation 40 Box 5 Euro area money market benchmarks: recent developments 43 2.2 The effective pass-through of the ECB’s monetary policy measures 45 2.3 Developments in the Eurosystem’s balance sheet 50 3 The European financial sector: resilient but confronted with challenges 54 3.1 Risks and vulnerabilities in the euro area financial system 54 Box 6 Developments in residential and commercial real estate markets in the euro area 58 3.2 The ECB’s macroprudential function 61 3.3 The ECB’s contributions to regulatory initiatives 63 3.4 The ECB’s microprudential function 68 ECB Annual Report 2017 1 4 Market infrastructure and payments 69 4.1 Innovation and integration of market infrastructure and payments 69 4.2 Safety of market infrastructure and payments 71 Box 7 Instant payments and retail payments innovation 72 Box 8 Cyber resilience of the financial ecosystem 73 5 Financial services provided to other institutions 75 5.1 Administration of borrowing and lending operations 75 5.2 Eurosystem Reserve Management Services 76 6 Banknotes and coins 76 6.1 The circulation of banknotes and coins 76 Box 9 The use of cash by households in the euro area 78 6.2 Counterfeit euro banknotes 80 6.3 The second series of euro banknotes 81 7 Statistics 82 7.1 New and enhanced euro area statistics 82 7.2 Other statistical developments 83 Box 10 Cooperation in the field of statistics at the European and international levels 85 Box 11 AnaCredit in the making: key features 87 8 Economic research 89 8.1 ECB research priorities 89 8.2 Eurosystem/ESCB research clusters and networks 90 8.3 Conferences and publications 91 9 Legal activities and duties 92 9.1 ECB participation in judicial proceedings at the EU level 92 9.2 ECB opinions and cases of non-compliance 93 9.3 Compliance with the prohibition of monetary financing and privileged access 97 ECB Annual Report 2017 2 10 International and European cooperation 98 10.1 European relations 98 10.2 International relations 100 11 External communication 102 11.1 Communication at the heart of ECB policy 102 11.2 Enhancing outreach 103 12 Institutional and corporate governance 104 13 Organisational and human resources developments 106 Annual Accounts A1 Consolidated balance sheet of the Eurosystem as at 31 December 2017 C1 Statistical section S1 ECB Annual Report 2017 3 The year at a glance In 2017, the economic recovery in the euro area developed into a solid and broad- based expansion. The economy grew by 2.5% and by the end of the year had recorded 18 straight quarters of growth. This represented the strongest expansion for a decade, and the broadest for two decades. The dispersion of growth rates among euro area countries fell to its lowest level since the start of Monetary Union. Robust growth ensured that the recovery in the labour market continued apace. Employment rose by 1.6% to reach its highest level ever, buoyed by record participation rates for women and older people. Unemployment fell to its lowest level since January 2009. Overall, 7.5 million jobs have been created since mid-2013, offsetting the total number of jobs lost during the crisis. As in previous years, the ECB’s monetary policy played a central role in this recovery and convergence story. In 2017, past asymmetries in the transmission of our monetary policy largely disappeared and financing conditions stabilised at record lows across the euro area. This contributed to the strongest increase in the growth of credit to the private sector since the crisis began in 2008. The robust performance of the real economy, however, was not matched by developments in inflation. While headline inflation recovered from its past lows, averaging 1.5% over the year, domestic price pressures remained muted and underlying inflation lacked signs of a sustained upward trend. The differing outlooks for growth and inflation shaped the ECB’s monetary policy decisions during the year, leading us to recalibrate our asset purchase programme. In October, the Governing Council decided to further reduce the pace of asset purchases from €60 billion to €30 billion per month, but to extend the programme by at least nine months until September 2018. Additionally, in March 2018 the Governing Council removed from its official communication the explicit reference to its readiness to expand the asset purchase programme if the outlook became less favourable. The Governing Council's decisions reflected its increased confidence in the outlook for the economy, in which context an unchanged policy stance would have become increasingly expansionary. But they also acknowledged that patience was needed for inflationary pressures to build up, and that persistence was necessary in our monetary policy for inflation dynamics to become durable and self-sustained. Though monetary policy is having its intended effects, it can also produce side effects. The ECB therefore continued to closely monitor financial stability risks in 2017, which appeared to be contained. Stronger nominal growth helped reduce risks by improving the debt sustainability of firms and households. Debt ratios in both sectors dropped to their early 2008 levels, ECB Annual Report 2017 4 indicating that the recovery has not come at the price of re-leveraging in the private sector. In fact, for virtually the first time since the start of Monetary Union, private spending has risen while private indebtedness has fallen. For banks, too, the improving economy offered a window of opportunity to further strengthen their balance sheets. The stronger economy helped stabilise profitability through higher business volumes and lower impairment costs. Banks’ shock- absorbing capacity continued to rise, with Common Equity Tier 1 ratios reaching 14.5% in the third quarter of 2017, and asset quality improved. Euro area banks accelerated their reduction of non-performing loans (NPLs), which decreased from 8% of total loans in 2014 to 5.2% in the third quarter of 2017. NPLs fell by €119 billion in the first three quarters of 2017 alone, with loan sales in secondary markets making up an increasing share of disposals. This was helped by ECB initiatives to improve transparency in NPL markets. However, further efforts to reduce high NPL stocks remain necessary. The ECB also continued to monitor financial market conditions. Markets were relatively calm in 2017, but remained vulnerable to an abrupt repricing of risk and increases in financial market volatility. These risks materialised in global equity markets in early 2018, although to date without significant spillovers to euro area credit markets and hence broader financial conditions. 2017 saw important developments in the payments architecture of the euro area as well. The final wave of migration to TARGET2-Securities was completed, and the platform processed an average of 556,684 transactions per day thereafter. The new €50 banknote was launched, improving payment security for euro area citizens, for whom cash remains the primary means of payment at points of sale. Finally, the ECB took a number of steps to improve its transparency and accountability towards EU citizens. We answered 138 questions from Members of the European Parliament in 2017. We opened our new Visitor Centre, which is expected to host 40,000 people a year. Our website had visitors from all over the world and was viewed over 17 million times. Looking ahead, we expect the pace of economic expansion to remain strong in 2018. While we remain confident that inflation will converge towards our aim over the medium term, there are still uncertainties about the degree of slack in the economy. A patient, persistent and prudent monetary policy therefore remains necessary to ensure that inflation will return to our objective. Frankfurt am Main, April 2018 Mario Draghi President ECB Annual Report 2017 5 The year in figures Solid and broad-based Inflation on a recovery path economic growth 2.5% 1.5% Year-on-year growth in euro area Average headline inflation gross domestic product profited from in the euro area increased, stronger net exports and robust largely reflecting rising energy domestic spending on goods and and – to a lesser extent – food prices. services. Employment above the Dispersion of growth rates pre-crisis level at a historical low 1998: 1.47σ 1.6% 2017: 0.75σ The recovery in the labour market In 2017 the difference in economic continued with robust employment growth rates across the euro area, growth, reflecting both the positive measured in standard deviations in economic climate and the success of gross value added, was the smallest policy measures. ever recorded in the history of Monetary Union. ECB Annual Report 2017 6 Improved bank solvency Accelerated reduction of non- performing loans 14.5% – €119 billion The solvency positions of euro area The total value of non-performing banks continued to improve, with loans of euro area banks decreased Common Equity Tier 1 ratios reaching notably in the first three quarters of 14.5% in the third quarter of 2017.

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