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15/12/2015

Central Bank of Malta Quarterly Review – Third Issue 2015

The Central Bank of Malta has published the third issue of its Quarterly Review for 2015, which analyses recent economic and financial developments in Malta and abroad. The Review also includes a number of analytical reports, namely on the relationship between inflation and economic conditions in Malta, the impact of fiscal policy measures on gross domestic product (GDP), as well as an overview of the latest extension to the Bank's macro-econometric model, which covers in more detail the links between the financial sector and the rest of the economy.

The Review highlights that, during the third quarter of 2015 and going into the following quarter, the Governing Council of the European Central Bank (ECB) maintained an accommodative monetary policy stance. This reflects concerns that euro area inflation will remain less than the target of below, but close to, 2.0% for a prolonged period.

On 3 December, the Governing Council decided on a range of additional measures in pursuit of the price stability objective. The deposit facility rate was lowered by 10 basis points to -0.30% in December. As regards non-standard measures, although the Governing Council maintained its target for monthly purchases of securities under its extended asset purchase programme (APP) unchanged at €60.0 billion, it extended the programme until at least the end of March 2017. The public sector purchase programme, moreover, was extended to euro-denominate securities issued by regional and local governments in the euro area. The Governing Council also decided to extend the fixed rate tender procedures with full allotment for as long as necessary and to re-invest the principal payments of debt securities purchased under the APP as they mature. At the same time, the ECB kept the interest rate on the main refinancing operations (MRO) unchanged at historical lows of 0.05%, while the rate on the marginal lending facility has also remained stable at 0.30%.

During the third quarter of 2015, GDP in the euro area rose by 0.3% on the previous quarter, with the expansion being driven by domestic demand. Inflationary pressures remained subdued, with the annual rate of inflation falling from 0.2% in June to -0.1% in September. Inflation turned positive in the fourth quarter, but remained weak, with the preliminary estimate for November at 0.1%.

According to the December Eurosystem staff macroeconomic projections, the economic recovery in the euro area is expected to continue, with real GDP growth projected to rise from 1.5% this year to 1.9% by 2017. Inflation is set to remain low, at 0.1% in 2015. It is then set to accelerate to 1.0% and 1.6% in 2016 and 2017, respectively.

Turning to domestic developments, the Review notes that the Maltese economy continued to expand at a robust pace. The initial estimates for the second quarter showed real GDP growing by 5.2% on the corresponding quarter of 2014, driven by domestic demand. In contrast, net exports had a dampening effect. During the third quarter, annual real GDP growth was 5.4%, down from an upwardly-revised growth rate of 5.8% in the previous quarter.


Buoyant economic activity was also reflected in the labour market. During the second quarter of 2015, employment continued to grow, while the unemployment rate maintained its declining trend. According to the Labour Force Survey (LFS), employment increased by 1.4% in annual terms. Meanwhile, the unemployment rate based on the LFS fell to 5.4%, from 5.8% a year earlier.

The annual HICP inflation rate in Malta stood at 1.6% in September, up from 1.1% in June. This acceleration was mainly due to developments in the prices of services, non-energy industrial goods and food. In October, the annual rate of HICP inflation remained stable at 1.6%. Compared with the euro area, Malta's inflation rate is closer to the monetary policy target, partly due to stronger economic activity and partly reflecting the impact of the euro depreciation since the beginning of the year on the price of imported goods and services from non-euro area countries.

In the external sector, during the second quarter of 2015 the positive balance on the current account of the balance of payments widened, compared to the corresponding period of 2014. This reflected a swing to net inflows on the primary income account and a higher surplus on services. These movements compensated for a larger merchandise trade deficit and a decline in net inflows on the secondary income account. As a result, in the year to June 2015 the current account surplus stood at 4.5% of GDP.

Turning to developments in money and credit, residents' deposits with Maltese banks continued to increase strongly, although the annual growth rate fell to 16.0% in September, from 19.1% in June. Meanwhile, the recovery in credit to residents progressed, with the annual growth rate rising to 4.8% in September, from 1.1% three months earlier.

Domestic money market yields were stable during the quarter under review. The three-month Treasury bill rate in the primary market remained at 0.00% between June and September. In the secondary capital market, however, government bond yields resumed their downward trend, with the ten-year yield falling by 48 basis points to 1.49% by the end of September and to 1.27% by end-October. As regards bank lending rates, the weighted average interest rate on outstanding loans to resident households and non-financial corporations fell by 4 basis points during the third quarter, standing at 3.85% at the end of September. 

Moving to fiscal developments, in the second quarter of 2015 the general government deficit narrowed on a year earlier, as revenue outpaced expenditure. As a result, the general government deficit, measured on a four-quarter moving sum basis, stood at 2.2% of GDP, down from 2.5% in the preceding quarter. The general government debt-to-GDP ratio also fell, standing at 68.9% in June. Consolidated Fund data show that during the first nine months of the year, the deficit narrowed compared with the corresponding period of 2014.

This edition of the Quarterly Review also carries the Bank's latest macroeconomic projections, which were concluded in November. The Bank foresees GDP growth to remain robust this year, at 4.1%, before easing over the following two years, reaching 3.2% in 2017. Domestic demand is set to be the main driver behind growth in activity over the forecast horizon.

HICP inflation is set to average 1.2% in 2015, but is set to pick up further in 2016 and 2017, reaching 1.9% in the final year of the projection horizon. In 2016, this acceleration largely reflects expected movements in energy and service prices, while an expected increase in the international oil price is set to boost inflation further in 2017.

Risks to both the GDP growth and inflation projections are balanced.

From a policy perspective, the recent narrowing in the fiscal deficit is welcome. However, the fiscal stance should remain oriented towards achieving the official Budget 2016 targets, which foresee a progressive narrowing of the fiscal deficit and a lowering of the debt ratio.

The financial system remains sound, supported by the core domestic banks' prudent business model, which in turn is reflected in their healthy capital and liquidity levels. However, further efforts are required to raise provisions against non-performing loans and strengthen capital buffers.

The non-standard measures of the ECB have had a positive effect on the Maltese economy, mainly through the exchange rate channel. These measures have also had a positive impact on the domestic stock and property markets.

At the same time, although bank lending rates have declined, they remain higher than in other euro area countries. In fact, in a recent report, the Malta Competition and Consumer Affairs Authority made a number of recommendations to address issues related to price transparency, barriers to expansion and consumer mobility in relation to interest rates on loans to small and medium-sized enterprises in Malta. There remains, therefore, scope for further improvement in terms of the transmission of the accommodative monetary policy stance of the ECB to domestic retail rates. Access to finance also needs to improve. A reduction in bank charges would ease funding conditions for firms, while also encouraging the use of more efficient means of payment.

The third issue of the Quarterly Review for 2015 is available on the website of the Central Bank of Malta.

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