The Central Bank of Malta has published the fourth issue of its Quarterly Review for 2010, which analyses economic and financial developments both in Malta and abroad during the third quarter of the year and going into the fourth.

The Review begins by analysing the European Central Bank’s (ECB) monetary policy stance. The ECB left official interest rates unchanged throughout the third and fourth quarters of 2010 and in January 2011 as the Governing Council expected price developments to remain moderate over the policy-relevant horizon and inflation expectations appeared firmly anchored. Consequently, the interest rate on the main refinancing operations was kept constant at 1.00%. Meanwhile, the Council continued to implement non-standard monetary policy measures to ensure that liquidity provision in the euro area remained ample

The Review then focuses on recent international economic and financial developments. It observes that the major industrial economies expanded at a faster rate, but quarterly growth patterns remained uneven. On the other hand, the principal emerging market economies continued to expand strongly. Inflationary pressures worldwide started to mount towards the end of the year, supported by higher energy and commodity prices.

Euro area economic activity expanded further during the September quarter. Real GDP grew at an annual rate of 1.9%, compared with 2.0% in the previous quarter. Growth was entirely driven by domestic demand. Meanwhile, annual HICP inflation accelerated moderately, rising to 1.8% in September from 1.4% in June. Subsequently, inflation continued to increase, reaching 2.2% in December. The Review notes that the December 2010 Eurosystem staff projections for the euro area point to annual real GDP growth ranging between 0.7% and 2.1% in 2011 and between 0.6% and 2.8% in 2012. According to these projections, inflation is set to lie between 1.3% and 2.3% in 2011 and between 0.7% and 2.3% in 2012.

Turning to the performance of the domestic economy, the Review comments that real GDP expanded by 3.6% on an annual basis during the third quarter, a slightly slower rate than in the previous quarter. Growth was primarily driven by exports, which rose faster than imports, as domestic demand remained subdued.

During the third quarter labour market developments reflected the broader ongoing recovery in the economy. Survey data for the third quarter and ETC records for August both indicated year-on-year increases in employment, while labour force participation also rose. Unemployment generally eased and continued its downward trend in the subsequent quarter.

As regards price developments, the Review observes that inflation continued to rise, reaching 2.4% in September from 1.8% in June, mainly driven by higher prices of unprocessed food and services. Inflation went up again in the following quarter, reaching 4.0% in December with significant contributions from unprocessed food, energy and services.

During the third quarter labour productivity rose faster than employee compensation resulting in a continued, but slower, decline in unit labour costs. However, during the final two quarters of the year the pick-up in domestic inflation contributed to an increase in the real Harmonised Competitiveness Index, indicating some erosion of international competitiveness.

On the balance of payments, the Review highlights that the balance on the current account shifted into surplus during the third quarter. Nevertheless, over the four quarters to September, the cumulative balance on the current account remained in deficit. Meanwhile, on the fiscal front, the Review notes that during the first nine months of 2010 the general government deficit declined compared with the same period of 2009, as revenue grew faster than expenditure. However, the general government debt continued to rise.

In its assessment of monetary developments, the Review highlights that the contribution of Maltese MFIs to the euro area broad money stock increased as growth in residents’ deposits kept up its momentum. At the same time, credit to residents expanded at a more moderate, though still substantial pace, while net claims on non-residents of the euro area rose for the third consecutive quarter. The weighted average interest paid by MFIs on bank deposits remained unchanged throughout the quarter, in line with the official interest rates, but the corresponding lending rate charged to residents increased.

The Review presents the Bank’s latest projections, which are based on information available until 19 November 2010. According to these projections, the Maltese economy expanded by 3.2% in 2010, though growth is set to moderate to 2.3% in 2011. Average annual HICP inflation is expected to slow down slightly to 1.8% in 2011. The projections are characterised by a high degree of uncertainty, with slightly downside risks to growth and upside risks to inflation, mainly reflecting rising international commodity prices.

From a policy perspective, the Review stresses the importance of ensuring that the recent pick-up in domestic inflation does not persist. It welcomes the recent improvement in the fiscal position and argues that budgetary consolidation will help ensure the sustainability of public finances and, if expenditure-based, could dampen inflationary pressures. Fiscal consolidation should also be accompanied by broader structural reforms to support growth and strengthen competitiveness, particularly by increasing product market competition and raising labour force participation and skill levels. Enhanced labour market flexibility and wage moderation would further contribute to this objective.

This issue of the Review carries the text of a speech delivered by the Governor last November on the medium-term prospects for the Maltese economy. It also contains an article summarising the results of a survey on wage and price setting in Malta.

The fourth issue of the Quarterly Review for 2010 is available on the website of the Central Bank of Malta at www.centralbankmalta.org

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