Based on Christine Lagarde’s latest press conference, it is clear that the ECB’s Governing Council view on the inflation outlook has evolved quite significantly. Since the December meeting, upside risks to inflation have increased, raising unanimous concern within the Council. Financial markets interpreted this as a signal that the first rate hike might come earlier than previously expected and bond yields moved significantly higher. The ECB’s forward guidance, which can also be considered as a description of its reaction function, suggests a rule-based approach to setting interest rates with clear conditions in terms of inflation outlook and recent price developments. In reality, a lot of judgment will be used as well
Against the background of economic recovery (real year-on-year GDP growth of 14.4% in Q2 2021, followed by 3.9% in Q3 and 4.6% in Q4 according to Eurostat’s preliminary estimate), outstanding bank loans to non-financial companies (NFCs) and households continued to accelerate in the eurozone between May and December 2021. Although substantial comparison effects mean that the figure is still in negative territory, its impulse (measuring the variation in annual growth in outstanding loans over one year) improved to -0.6% in December 2021.
Although Germany is not the eurozone country experiencing the highest inflation rate, the trend is nevertheless uncomfortable. Consumer prices posted another hefty rise in January (+5.1% y/y, harmonised index), although this was less than in December 2021 (+5.7%). The end of positive base effects – caused by the end of the VAT rate cut in place in the second half of 2020 – did not therefore result in a marked fall in inflation.
Usually close, French and German inflations, measured on a comparable basis by Eurostat’s harmonized index of consumer prices (HICP), have diverged sharply since the beginning of 2021, with inflation on the other side of the Rhine largely exceeding that in France. In November 2021, the gap reached +2.6 percentage points compared with an average of +0.2 pp since 1991. This difference is, for a part, due to a VAT effect: the decrease in the German rates in the second half of 2020 initially pulled down German inflation but the return to their previous level reverted that trend in 2021. In January 2022, with the end of this VAT effect, German inflation fell back quite significantly (to 5.1% y/y according to Eurostat’s flash estimate, from 5.7% in December) but is still very high
Economic newsflow was particularly rich last week. The first important items, looking in the rear-view mirror, were the first growth estimates for Q4 2021 in France, Germany and Spain. Performances were mixed, between the 0.7% q/q contraction in Germany, further strong growth of 2% q/q in Spain and, between these two, growth of 0.7% q/q in France.
French industry is benefitting from helpful conditions. Production has been boosted by order books that have filled up since spring 2021 and by growing capacity to meet this demand. The INSEE January 2022 business survey showed that inventories of finished products had increased to nearly 84% of their normal level, something not seen since mid-2020. This phenomenon is particularly visible in intermediate goods sectors. In chemicals, plastics and packaging (the ‘wood and paper’ segment), the percentage of current inventories in proportion of a normal level has bounced back even though it remains below this normal level. In metals and electrical equipment, very high inventory levels reflect very strong activity
The French economy seems to be getting off to a relatively good start in 2022, despite the introduction of tighter restrictions as a result of the Omicron wave. Positive momentum in the fourth quarter of 2021 – likely to be confirmed by GDP figures due on 28 January – has continued overall in the manufacturing and construction industries.
With less than two weeks to go before Italy’s presidential election – the first round of voting takes place on 24 January – a candidacy of the current Prime Minister, Mario Draghi, remains a distinct possibility. If Mr Draghi becomes Italy’s president, this would probably have repercussions for the current governing coalition, although it is not currently possible to predict what they might be. In the meantime, Covid-19 cases are continuing to surge, with around 170 000 new contaminations recorded in mid-January. This has prompted the government to make vaccinations compulsory for people aged over 50.
The fairly substantial upgrade to Spain’s Q3 GDP figures underlined again the problems that the Spanish statistical office (INE) is currently facing when collecting data. To recap, third-quarter growth was revised up from 2.0% q/q to 2.6% q/q and this follows a large downgrade for Q2, from 2.8% q/q to 1.1% q/q. Employment will remain in the spotlight in 2022, since it offers a parallel measurement of economic activity and one that is currently more accurate than GDP.
The indicators currently available for the end of last year suggest that Germany recorded weak growth at best in Q4 2021: a GDP contraction cannot be ruled out. Industrial orders remained at a relatively strong level, but production continued to be held back significantly by supply problems for certain components.
Euro notes and coins were introduced on 1 January 2022, and the euro is celebrating that 20th anniversary in fairly good shape. However, there are still many plans to improve and strengthen the European project and increase integration. This is shown by the topics on the agenda during the French presidency of the Council of the European Union over the next six months. Priorities will include reforming European fiscal rules, which will be a major topic of debate in 2022. Discussions are underway and decisions should be made this year. The challenge will be to avoid an anticlimax
Instead of drastically restricting conditions of activity, the government only made a few adjustments to their policy for combatting the pandemic: the state of emergency was extended for three months to 31 March 2022. Despite the resurging pandemic, business prospects are still looking upbeat this winter. PMI indices are holding at high levels, especially for the manufacturing sector. In November, the manufacturing PMI rose 1.7 points to a new high of 62.8, supported by the improvement of the employment and new orders components. The services PMI also improved, up 3.5 points to 55.9. The composite PMI for the past three months has held steady compared to three previous three months, as shown in the Pulse below.
Despite a substantial increase in new Covid-19 infections since the start of November, the infection rate is currently below those in France or Germany. Meanwhile, concerns about the health situation have had little effect on business confidence so far: the PMI Composite index improved in November (up 1.9 points to 58.3) thanks to better prospects in services. The positive trend in this sector can also be seen in the European Commission survey, which reveals levels of optimism not seen for twenty years. This said, household confidence has fallen back, mainly due to fears of rising consumer prices.
The resurgence of the Covid-19 pandemic and the emergence of the new Omicron variant make the ECB’s task even harder. Although growth should hold at a high level, it is expected to ease, and this trend could worsen, at least in the short term. Meanwhile inflation continues to soar, while becoming more broadbased, and the risk in the coming months is on the upside. Faced with greater uncertainty, the ECB is arguing in favour of patience and constancy while saying it is ready to act in any direction. According to our scenario, which is somewhat optimistic in terms of growth and calls for persistent inflation, the ECB would end its Pandemic Emergency Purchase Programme (PEPP) in March 2022 and begin raising its key deposit rate in mid-2023.
After strong growth in Q2 and Q3, the business climate deteriorated due to supply problems, the increase in prices and the surge in Covid-19 infections. Output is likely to stagnate around the turn of the year. The new government will put the emphasis on social and environmental policies, while fully respecting the fiscal framework, important for Germany. Private consumption will be the major engine for growth in 2022.
Factors hampering growth in the short term are gaining strength (supply chain disruptions, surging inflation, and the resurgence in the Covid-19 pandemic), but the resilience of business sentiment through November as well as numerous targeted measures to support household purchasing power help allay fears. In Q4 2021, we are forecasting growth of 0.6%, although the risk is on the downside. In full-year 2021, growth is expected to average 6.7%. In 2022, it will remain a robust 4.2%, bolstered by the accommodative policy mix, the unblocking of excess savings, the catching-up of the services sector as well as strong investment and restocking needs.
After a modest expansion in Q1 2021, real GDP rose by more than 2.5% q/q in both Q2 and in Q3. This recovery was widespread. In Q3, net exports added 0.5 percentage point to GDP growth thanks to a stronger rise in exports than imports. Thanks to the easing of social restrictions, consumption has further increased, while favourable financing conditions and fiscal incentives have supported investment. During the summer, the recovery expanded to the services sector, which benefitted from higher tourist receipts. Manufacturing production has recovered entirely from the 2020 decline, ending up 2% higher than in Q4 2019. Labour market conditions are not as good as the recovery would suggest.
Despite a rather weak recovery in GDP, the Spanish economy has been much more resilient on the labour market front in 2021. Employment (November) and the participation rate (Q3) are at record levels. Inflation will be one of the biggest obstacles in 2022, the increase in production prices having accelerated markedly this autumn. Support for growth will remain a government priority in 2022. The country will benefit from a larger transfer of European funds that will help finance a record budget of EUR196 billion. The reduction in the government deficit will be again pushed into the background, the authorities mainly betting on economic growth to reduce the deficit-to-GDP ratio.
Q3 Belgian GDP growth came in at 2% q/q, which is well above consensus. GDP thus exceeded its pre-Covid level for the first time since the start of the pandemic. For this year, we estimate the growth rate to reach 6.1% in annual average terms, with a slower but still above-potential growth rate of 3.1% expected for next year. As it stands, the Belgian economy looks to have avoided additional scarring; however, with elevated public debt levels entering the limelight once again, the De Croo government has its work cut out.
Once Covid-related restrictions are lifted, the economy is projected to rebound strongly in 2022, driven initially by household consumption. Next year, the fiscal stance is likely to tighten because of the gradual withdrawal of the special support measures. A major political risk is the possible falling apart of coalition between the conservative ÖVP and the Greens.
Confronted like the rest of Europe by an upsurge in Covid-19 cases, Finland has reintroduced protective health measures that could temporarily dampen its recovery. Estimated at 3.4% in 2021, GDP growth could still reach 2.8% in 2022 according to the European Commission. After taking a reasonable approach to “whatever the cost”, the government is now seeking to consolidate public finances.
The Greek economy has surprised on the upside so far in 2021. Real GDP growth is expected to exceed 7% this year. The unemployment rate has fallen to 13% in September. This improvement has allowed the banking sector to continue its clean-up, with a non-performing loan ratio close to the 20% threshold at the beginning of the summer. Difficulties on the economic, social and banking front remain amongst the most pressing in the European Union. This said, unless there is a further complication on the health front, Greece will go into 2022 on a much better basis than in previous years.
The public and private moratoria granted since the onset of the Covid-19 pandemic to the Portuguese non-financial private sector[1] have, to a very large extent, now expired. The outstanding amount of loans under moratoria stood at EUR3.1 bn in October 2021, from EUR3.6 bn in March 2020 and a peak of EUR46.3 bn in September 2020. Moratoria now cover only 1.5% of outstanding loans to households and non-financial corporations, from 1.9% in March 2020 and 23.5% in September 2020. The expiry of moratoria since September 2021 has not, so far, resulted in a significant increase in non-performing loans[2]. Their outstanding amount (EUR4.0 billion) and ratio (2.0% of loans) have returned to their July 2008 levels
In most European countries, the structural primary deficit should shrink next year. This reduction represents a negative fiscal impulse, raising concern that it would act as a headwind to growth. However, the level of the primary deficit is such that it still corresponds to an accommodative fiscal stance. Taking into account national fiscal policies as well as expenditures financed by the Recovery and Resilience Facility and other EU grants, fiscal policy in the euro area should have a significant positive impact on GDP growth next year, thereby accompanying and strengthening the ongoing recovery. In addition, it should enhance the effectiveness of the ECB’s accommodative policy.
The ECB’s meeting on 16 December is highly anticipated, primarily for the central bank’s new growth and inflation forecasts. When it comes to growth, the ECB’s September forecast was for annual average growth of 5% in 2021, 4.6% in 2022 and 2.1% in 2023. It could leave its 2021 forecast unchanged, with the positive figures for Q3 offset by a less positive view of Q4, due to the effect of supply constraints, inflationary pressures and a resurgence of the pandemic. Growth in 2022 will be weakened by the same factors. The scale of the forecast downward revision will indicate the level of the ECB’s concerns. It will also be interesting to see whether any growth ‘lost’ in 2022 will be shifted, in part at least, into a higher forecast for 2023.
