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European Chart Book

European Chart Book

Tailwinds fading, headwinds building

With some important exceptions, including the German manufacturing sector, economic activity seems to have held up a little better than we had feared so far in Q2. We don’t think this will last. The recent strength has been helped by the re-opening of high-contact services including hospitality and travel which already seems to be fading. What’s more, the manufacturing sector is still meeting the backlog of unfulfilled orders whereas new orders have slumped over the past couple of months. With both the headline and core inflation rates at record highs in May, the ECB is set to raise interest rates significantly in the second half of the year. That is leading to higher borrowing costs for households which are already struggling with the cost-of-living crisis driven by higher energy and food prices.

7 June 2022

European Chart Book

Inflation becoming more entrenched

The latest data suggest that the increase in inflation is becoming more broad-based and persistent. While headline inflation only edged up in April, the core measure jumped to 3.5%. A range of alternative measures of underlying inflation, including our own proprietary indicator, also rose sharply. Surveys suggest that businesses and households have been revising up their inflation expectations, and this is echoed in market-based measures of inflation expectations. All of this has prompted financial markets to come round to our view that the ECB will raise its deposit rate by 25bps in July and lift it to positive territory by the end of the year. We now see the risks to our forecast as tilted to the upside. Attention is soon likely to turn to how tighter monetary conditions will impact the real economy and whether they will cause an excessive widening of sovereign bond spreads. UK Drop-In (5th May 10:30 EDT/15:30 BST): Our UK Economics team are holding a special 20-minute briefing to discuss the latest MPC decision and what it means for their outlook for UK growth, inflation and BoE policy. Register now

5 May 2022

European Chart Book

Stagflation risks rising

The risk of stagflation has risen substantially. The latest surveys suggest that the economy held up pretty well in March, but the forward-looking indicators paint a much gloomier picture of the months to come. The Sentix investor sentiment indicator has only reached its current low levels on two previous occasions: during the global financial crisis and the euro-zone debt crisis.  Meanwhile, the inflation data have continued to come in above expectations, with the headline rate averaging 6.2% in Q1, more than half a percentage point higher than the ECB forecast in March when it already had the January data and the flash estimate for February. And moves in commodity prices, as well as the timeliest survey indicators, suggest that price pressures have intensified since the war in Ukraine began. Despite the hit to economic activity from the war, we think that the strength of inflation will prompt the ECB to begin tightening monetary policy sooner than is currently priced into markets.

7 April 2022
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European Chart Book

Ukraine war stokes inflation, reduces growth

The war in Ukraine has prompted us to revise our forecasts for euro-zone GDP, inflation and monetary policy. Russia’s downturn in 2015 had no obvious impact on euro-zone GDP and Russia has become less important as an export market since then. But we expect a much deeper recession in Russia this year, and the spillovers to Europe will be larger due to the severity of the sanctions. For now, we are cutting our euro-zone GDP growth forecast for this year from 3.5% to 2.8%. Meanwhile, the recent surge in commodity prices, together with upside surprises to inflation in January and February, mean that we now think headline inflation will average around 5.5% this year and 2.5% next year, well above the ECB’s 2% target. Finally, the war seems to have made policymakers at the central bank more cautious, so we think they will wait a little longer before tightening policy than previously seemed likely. We now anticipate one 25bp rate increase late this year and another 50bp during 2023. Drop-In (8 March, 10:00 EST/15:00 GMT): We’re discussing Russian energy imports and Europe’s energy needs in this special 20-minute briefing on one of the big sticking points in the western response to the war in Ukraine. Register here.

European Chart Book

Shift in ECB stance poses risks to the bond market

Both we and the market are now discounting 100bp of ECB rate hikes by the end of 2023. And given the sequencing set out by Christine Lagarde, it seems likely that net asset purchases will end in Q3 this year at the latest. There are a number of reasons why the region is better placed to handle tighter monetary policy than it was in 2011, including lower debt servicing costs and the longer average maturity of government bonds. But peripheral spreads have widened markedly in the past few days, which will test the ECB’s tolerance for tighter financing conditions. The market reaction strengthens the case for the Bank to remain open to re-starting bond purchases even after it has started raising policy rates. Drop-In (10 February, 11:30 GMT): The Riksbank’s dovish stance looks increasingly untenable in a world of policy tightening, but how far will it go to embrace the hawkishness of its peers? David Oxley and Jonas Goltermann will be online to discuss the Swedish monetary policy outlook following the latest statement this Thursday. Registration details.

European Chart Book

Inflation to remain above target in 2022

Euro-zone inflation reached 5.0% in December, which is likely to be the peak. Unless oil and gas prices surge again in 2022, which seems unlikely, energy inflation will plummet – we forecast the contribution of energy to headline inflation to drop from 2.5 percentage points in December 2021 to around zero in December 2022. But we don’t expect to see a downward trend in core inflation. The full impact of high input prices has probably not yet fed through to core goods inflation, which was already at a record high at the end of last year. In the near term, the Omicron variant could lead to a bigger reduction in global supply than demand, adding to inflationary pressures. And if demand rebounds when Omicron cases start to fall, as we expect, it could push up wage growth and services inflation. We forecast core inflation to average a little over 2% this year, which would put more pressure on the ECB to prepare the ground for interest rates to rise in 2023.

European Chart Book

Omicron adds to downside risks

High frequency data show that travel to retail and recreation destinations, restaurant bookings and flights have all declined in the past few weeks as coronavirus restrictions have been tightened in the face of rising hospitalisations. It now looks likely that GDP growth will be lower than our forecast of 0.7% q/q in Q4. The Omicron variant has added to these downside risks although at this stage its transmissibility, severity and capacity to escape vaccines are unknown. Meanwhile, we think euro-zone inflation has probably peaked at nearly 5% in November. If restrictions are tightened sharply, energy inflation may fall more than we have assumed, pulling headline inflation down a bit further and faster than we are assuming. But core inflation – which matters more to central bankers – could end up higher than anticipated if supply problems last for longer. Either way, it now seems likely that the ECB will maintain some capacity to keep bond purchases high and flexible beyond next March.

European Chart Book

Recovery slowed by supply chain problems

Economic growth has slowed sharply as output approaches its pre-pandemic level. We think that GDP will probably increase by only around 0.5% q/q in the final quarter, down from 2.2% in Q3. Manufacturing firms in Germany are struggling more than most and a large majority of them are reporting shortages of materials. At the same time, price pressures have continued to increase, with both the input price and output price components of the euro-zone Composite PMI reaching record highs in October. The euro-zone inflation rate reached 4.1% in October and is likely to edge up a bit further before year-end. However, it should then fall over the course of 2022 as energy inflation declines. The ECB is likely to leave its key policy rate unchanged at -0.5% throughout next year, and probably well beyond that, as it will continue to judge that the increase in inflation will prove transitory.

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