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.
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