The Central Bank’s fourth quarterly Review for 2008, just published, observes that the worsening economic conditions overseas pose downside risks to economic growth in Malta. However, monetary policy has been eased considerably, and this should counter the adverse effects of the international financial crisis on the real economy. Cuts in official interest rates have largely been transmitted to the banks’ customers, but it is also important to maintain the flow of credit to healthy borrowers. In addition, it is important for the economy to achieve further productivity gains in order to allow it to maintain external competitiveness and take advantage of the eventual recovery.

The Central Bank of Malta fourth issue of its Quarterly Review for 2008 analyses economic and financial developments in Malta and abroad during the third quarter of 2008 and into the fourth. Additionally, the Review carries a speech delivered by the Governor at the Institute of Financial Services Annual Dinner on the implications of the international financial crisis for Malta.

The Review reports on the ECB’s monetary policy stance and notes that the Governing Council raised the minimum bid rate on its main refinancing operations by 25 basis points to 4.25% in July 2008, before leaving official interest rates unchanged throughout the remainder of the third quarter. During the final quarter of the year, however, as the economic outlook deteriorated sharply and inflationary pressures receded, the ECB lowered the interest rate on the main refinancing operations on three occasions, for a cumulative drop of 175 basis points, bringing it down to 2.50% by the end of the year. Moreover, on 15 January, the ECB cut the rate by another half of a percentage point as the economic outlook weakened further and inflationary pressures continued to diminish.

The Review observes that economic activity in the major industrialised countries continued to slow down during the third quarter of 2008 as the financial market crisis intensified and its negative impact spilled over onto the real economy. Meanwhile, inflationary pressures eased in response to lower commodity prices and falling global demand.

In the euro area, real GDP contracted during the third quarter, while the annual rate of growth declined. Domestic demand was subdued and the contribution from net exports turned negative. After peaking in July, the annual rate of inflation, as measured by the Harmonised Index of Consumer Prices (HICP), fell steadily, dropping to 2.1% in November.

The Review then focuses on the domestic scene and notes that in the third quarter the economy continued to expand, albeit at a slower pace. The annual rate of growth of real GDP stood at 2.2%, down from 3.5% in the second quarter. The deceleration was primarily due to sluggish external demand, while domestic demand remained generally buoyant, with both household and government consumption contributing substantially.

Developments in the labour market remained generally positive, with increases in the number employed and a further reduction in the unemployment rate. With regard to price movements, annual HICP inflation accelerated in the third quarter, mainly as a result of higher prices of services, food and energy. This trend was maintained in October with the annual HICP inflation rate rising markedly to 5.7%, before easing in November.

Meanwhile, Malta’s external price competitiveness, measured in terms of both unit labour costs and the harmonised competitiveness indicator (HCI), deteriorated over the September quarter. Compared with developments in the euro area as a whole, however, Malta’s unit labour costs increased at a slower pace, although the HCI rose more rapidly.

On the external side the current account of the balance of payments ended the third quarter of 2008 in surplus, as is usually the case at this time of year. Nevertheless, the surplus was considerably smaller than that registered a year earlier due to a larger merchandise trade deficit and lower net inward transfers. Movements in these components offset a significant rise on the services balance and lower net investment income outflows.

In terms of perceptions and outlook, the Bank’s quarterly survey, conducted among firms in the service and construction industries, showed that sentiment worsened during the fourth quarter of 2008. Moreover, participants generally anticipated lower turnover and higher costs in the following quarter. Meanwhile, according to the European Commission’s surveys, industrial and consumer sentiment in Malta also deteriorated.

Regarding fiscal developments, the Review observes that the deficit on the Consolidated Fund widened during the first eleven months of the year, as expenditure increased by a larger amount than revenue. Correspondingly, the general government deficit also expanded during the first three quarters of 2008.

The Review then comments on the contribution of Maltese MFIs to the euro area broad money stock. This increased during the September quarter as residents’ deposits recovered. At the same time, credit to residents of Malta grew at a moderate pace, while net claims on non-residents of the euro area also registered a rise. Reflecting developments in the euro area, yields on Treasury bills and Malta Government Stocks fell, whereas equity prices continued to decline.

In summarising overall developments in the international and domestic economy, the Review observes that the worsening economic conditions overseas pose additional downside risks to economic growth in Malta. However, monetary policy has been eased considerably, and this should counter the adverse effects of the international financial crisis on the real economy. Cuts in official interest rates have largely been transmitted to the banks’ customers, but it is also important to maintain the flow of credit to healthy borrowers. In addition, it is important for the economy to achieve further productivity gains in order to allow it to maintain external competitiveness and take advantage of the eventual recovery.

The fourth issue of the Quarterly Review for 2008 is available on the website of the Central Bank of Malta at www.centralbankmalta.org