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Deeper recession and more persistent inflation

The euro-zone is on the cusp of a significant recession due to a severe squeeze on households’ real incomes, rising interest rates and weak external demand. We now think GDP will fall for the next three quarters and will recover only gradually after that, and we expect the unemployment rate to rise next year. Despite this, headline inflation will remain stubbornly high and core inflation – which excludes energy and food prices – will be stuck well above the ECB’s target for at least the next two years. Against this backdrop, the ECB is set to raise its deposit rate rapidly to a peak of around 3%. However, rather than beginning to shrink its balance sheet, we think the Bank is likely to resume net asset purchases in order to prevent peripheral bond yields from surging.

Note: We’ll be discussing key takeaways from this report in a Drop-In on Tuesday, 25th OctoberRegister here.

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