OREANDA-NEWS. The Central Bank of Malta has published the second issue of its Quarterly Review for 2015, which analyses recent economic and financial developments in Malta and abroad. The Review also carries a number of analytical reports, namely on the macroeconomic impact of a new policy allowing the extension of hotel heights, the effects of income tax reductions in Malta, as well as a short study on hourly labour costs.

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

The ECB kept the interest rate on the main refinancing operations (MRO) unchanged at 0.05%, while the rate on the marginal lending facility and the deposit facility rate also remained stable at 0.30% and -0.20%, respectively. Meanwhile, the Governing Council maintained its target for monthly purchases of securities under its extended asset purchase programme (APP) unchanged at €60.0 billion.

During the second quarter of 2015, gross domestic product (GDP) in the euro area rose by 0.4% on the previous quarter, with the expansion being mainly driven by net exports and private consumption. Inflationary pressures remained subdued. The annual rate of inflation in the euro area, as measured using the Harmonised Index of Consumer Prices (HICP), rose from -0.1% in March to 0.2% in June, and remained at this level in July.

According to the September ECB staff macroeconomic projections, the economic recovery in the euro area is expected to continue, with real GDP growth projected to pick up from 0.9% in 2014 to 1.4% this year, before accelerating further, to 1.8% in 2017. Meanwhile, inflation is set to remain low, at 0.1% in 2015. It is then set to accelerate to 1.1% in 2016 and to 1.7% in 2017.

Turning to domestic developments, the Review notes that the Maltese economy continued to expand at a robust pace in the first half of 2015. The initial estimates for the first quarter showed real GDP growing by 4.0% on the corresponding quarter of 2014. During the second quarter, annual real GDP growth accelerated to 5.2%, from an upwardly-revised growth rate of 4.9% in the previous quarter.

The annual HICP inflation rate in Malta stood at 1.1% in June, up from 0.5% in March. This acceleration was mainly due to energy inflation, which became less negative, and to developments in processed food prices. In July the annual rate of HICP inflation edged up to 1.2%.

With regard to the labour market, employment continued to grow, while the unemployment rate maintained its declining trend during the first quarter of 2015. According to the Labour Force Survey (LFS), employment increased by 1.3% in annual terms. Meanwhile, the unemployment rate based on the LFS fell to 5.7%, from 6.0% a year earlier.

In the external sector, during the first quarter of 2015 the current account of the balance of payments posted a surplus as opposed to a deficit in the corresponding period of 2014. This swing mainly reflected a smaller deficit on trade in goods, although income related flows also contributed. In contrast, net receipts on services declined on a year earlier. As a proportion of GDP, in the year to March 2015 the current account surplus stood at 5.5%.

Turning to developments in money and credit, residents' deposits with Maltese banks continued to increase strongly, posting an annual growth rate of 19.1% in June, up from 14.6% in March. Meanwhile, the recovery in credit to residents gathered pace, with the annual growth rate rising to 1.1% in June.

Domestic money market yields remained unchanged during the quarter reviewed. The three-month Treasury bill rate in the secondary market remained unchanged at 0.00% between March and June. In the secondary capital market, however, government bond yields increased, with the ten-year yield rising to 1.97%, though they fell back somewhat in July. Meanwhile, bank lending rates edged down, with the weighted average interest rate on outstanding loans to resident households and non-financial corporations falling by 8 basis points to 3.90% at the end of June.

Moving to fiscal developments, in the first quarter of 2015 the general government deficit widened on a year earlier, as expenditure outpaced revenue. As a result, the general government deficit, measured on a four-quarter moving sum basis, rose to 2.5% of GDP, from 2.1% in the last quarter of 2014. The general government debt-to-GDP ratio also went up, while remaining below the level recorded a year earlier. However, Consolidated Fund data show that during the first half of the year, the deficit narrowed significantly compared with the corresponding period of 2014.

From a policy perspective, the recent abrogation of the Excessive Deficit Procedure for Malta is welcome. However, the fiscal stance should remain oriented towards achieving the official targets, which foresee a progressive narrowing of the fiscal deficit and a lowering of the debt ratio.

The financial system remains sound and resilient, supported by a growing Maltese economy. Core domestic banks' capital levels remain healthy, while liquidity is ample. However, further efforts are required to raise provisions against non-performing loans. Given the higher capital regulatory standards entailed in Basel Agreements, Maltese banks should also strengthen their capital buffers and maintain prudent dividend pay-out policies.

Although the non-standard measures of the ECB have been reflected to some extent in lower lending rates to the private sector, there remains scope for further rate cuts and for using the liquidity obtained through the ECB's APP to improve the flow of credit to the economy. It remains important to ensure that the private sector, particularly small and medium enterprises, benefits from improved access to finance. The Bank supports institutional developments in this area, notably the establishment of a development bank.