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.
The rising trend in prices in the USA is far from over and has become a real focus of attention. In November 2021, inflation was 6.8% year-on-year (yy), its highest level since June 1982. Although soaring energy prices (up 33% yy) contributed to the increase in the cost of living, as in previous months, these were no longer the sole cause. Even stripping out energy and food, inflation was still 4.9% in November, another record. Having risen by 3.9% yy, rents, which represent the main item of expenditure for households (33% of the index), are beginning to have a significant effect. Far from being anecdotal, their increase has accelerated month after month in the wake of the surge in real estate prices
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.
In his testimony to a commission of the US Senate, Jerome Powell has acknowledged that inflation is less transitory than considered hitherto, adding that, as a consequence, a faster tapering seems warranted. Despite this hawkish tone, the reaction of US Treasuries was muted. This may, amongst other things, reflect concern about how the pandemic might evolve. The new Omicron variant undeniably represents an uncertainty shock for households and companies. It comes on top of a negative supply shock that is already a clear headwind to demand. It clearly makes the task of central banks more complicated than ever when deciding how much of a monetary headwind they can create.
The ECB insists on the need for patience before considering a policy tightening, despite current elevated levels of inflation. It believes that inflation will decline next year and that a wage-price spiral is unlikely to develop. Moreover, inflation expectations remain well anchored. Demand in the euro area is suffering from the headwind created by the jump in energy prices. Reacting to this type of inflation by tightening monetary policy would create the risk of reducing demand even more. To avoid such an outcome, it makes sense for the central bank to wait for more information to arrive, thereby adopting a risk management approach of monetary policy
In the euro area, business surveys report record-high staff shortages. They represent a headwind to growth and raise the possibility of faster wage growth and a pick-up in inflation. Thus far, growth of negotiated wages has been subdued but, given its historical relationship with labour market bottlenecks, an acceleration seems likely. Despite the difficulties of companies in filling vacancies, labour market slack has remained above pre-pandemic levels. This situation should improve in the coming months but whether this eases labour market tensions depends on companies’ hiring intentions. Based on recent surveys, these should remain elevated.
The “transitory” surge in inflation is proving to be long lasting. In October, US inflation rose to 6.2% year-on-year, the highest level in 31 years. As in previous months, the main explanation is a ballooning energy bill (which accounts for 30% of this figure), but the acceleration in prices is spreading throughout the US economy. It can be seen in the cost of shelter, which is already up 3.5% year-on-year, and is surely bound to accelerate.
Emerging economies have faced mounting inflation pressures since the beginning of 2021. Headline inflation has continued to accelerate over the summer (except in Asia), primarily reflecting the rise in food and energy prices and weaker currencies against the USD. However, core inflation has also accelerated across the board. As a result, a growing number of central banks in Latin America and Central Europe have started to raise their policy rates. In Asia, inflation has remained low (North Asia) or has levelled off (India), allowing central banks to stay accommodative. So far, central banks engaged in a tightening cycle have increased their policy rate cautiously; even the more reactive ones (in countries such as Brazil and Russia) have remained behind the curve (i.e
Although the significant increase in inflation in most advanced economies is expected to be transitory, it is necessary to focus on the potential consequences of inflation staying temporarily high for longer. Companies that hitherto have been reluctant to raise prices might do so after all, higher inflation could weigh on spending but also cause wage demands to grow, inflation expectations could drift higher, the market sensitivity to growth and inflation surprises would increase and there could be fears about a change in the reaction function of the central bank. In the coming months, investors and central banks will scrutinise data in parallel, but the former will react more quickly should inflation stay high.
In the past few months, activity was hampered by the state of emergency in large parts of the country, which affected in particular the services sector. In addition, the manufacturing sector was confronted with supply disruptions, specifically in the car industry. Finally, the substantial base effects related to the pandemic make it difficult to interpret the year-on-year data.
Since year-end 2020, Eurozone inflation has risen almost vertically. A year ago, year-on-year inflation was still slightly negative, but by September 2021, it had risen to 3.4% (according to Eurostat’s preliminary estimate), the highest level since September 2008. The surge was strongest in Germany, followed by Spain, and to a lesser extent, Italy and France. In Germany, inflation bears the marks of the temporary VAT cut in H2 2020. In Spain, the upturn in energy prices was accentuated by a higher VAT rate on electricity than in most of the other European countries. The updating of weights in the price index also played an important role at the beginning of the year
After the disappointing economic growth reported in H1 2021, Spain should record a robust rebound in activity in H2, assuming the health situation does not deteriorate. The inflow of tourists has picked up (but remains historically low) and employment has recovered. Yet inflationary risks are intensifying. With the surge in energy prices, the government was forced to take drastic measures to reduce the energy bill for households, which will weigh on public finances. Faced with a persistently uncertain environment, the government is bound to maintain an expansionist policy when it unveils its 2022 budget this fall, even though the health situation is more favourable for the moment thanks to the high level of vaccinations
When the pick-up in inflation during a growth upswing is driven by the demand side, inflation is considered to be good. However, inflation can also be bad. In that case, higher prices do not follow from e.g. higher wages due to a tight labour market. Bad inflation rather reflects supply-side shocks. This is, to some degree, the situation that is unfolding in the Eurozone and other economies due to the recent huge increase of oil and gas prices. Bad inflation weighs on households’ real disposable income and hence spending. The impact is expected to be larger for households at the lower end of the income distribution, considering that a bigger portion of their expenditures goes to fuel and in particular heating, and that they also have a lower savings rate.
The new macroeconomic projections of the ECB staff provide sobering reading for savers hoping that, one day, the policy rate will be raised. It is clear that at the current juncture, certain conditions of the recently updated forward guidance on interest rates states are not met. Based on the latest ECB projections, it seems this would still be the case in 2023, even under the hypothesis of a mild scenario. The slow increase of underlying inflation would probably be considered as unsatisfactory. Savers can only hope that the interaction between growth and inflation will evolve or that the ECB projections turn out to be too cautious.
The outcome of the ECB’s strategy review shows that the governing council has carefully listened to what its audience had to say. Its inflation objective is now truly symmetric, which addresses the perception that its previous objective was asymmetric. Three other changes reflect points that were strongly emphasized during the outreach events organised by the Eurosystem. The cost of owner-occupied housing will be taken into account when assessing the inflation environment. The communication will become geared towards a broader public and a decision has been taken to commit to an ambitious climate-related action plan. Now it’s back to the hard work of trying to push inflation up to 2%.
The Eurozone economy is bouncing back. From a macroeconomic perspective, the region is closing the gap on the losses accumulated since spring 2020 more quickly than expected just a few months ago. Unless a new wave of the pandemic breaks out due to the spread of Covid-19 variants, Eurozone GDP should return to pre-crisis levels by the end of the year. Accelerated vaccination campaigns and the gradual lifting of health restrictions are reducing uncertainty and boosting the confidence of economic agents. Consumers, who have adapted to restrictive health measures, are playing a key role. Despite these favourable dynamics, public policies are remaining cautious
Despite a sharp increase in May (+1.98%), eurozone inflation continues to be driven by two components of the consumer price index (CPI) that are linked to energy prices. “Operation of personal transport equipment” was by far the biggest contributor to the rise in the CPI with a contribution of 0.87 percentage points (pp), or nearly half of headline inflation. This reflects the increase in pump prices. It is followed by “Electricity, natural gas and other fuels”, which contributed 0.43 pp to Eurozone headline inflation
Eurozone inflation rose markedly in Q1 2021 and seems to be extremely volatile. Core inflation, which is usually stable, has been moving in fits and starts.The rebound in goods prices largely explains the broad increase in inflation. Prices of tradeable services have also picked up, notably in the sectors that were hit hardest by the pandemic, such as transport. The recent acceleration in prices is being driven by temporary factors: changes in VAT rates, higher crude oil prices, and the revision of HICP weights. Inflation could continue to rise over the next few months.These temporary effects should dissipate at the beginning of next year. Thereafter, there seems to be very little risk of an inflationary surge in the Eurozone.
The sharp rise in household inflation expectations is one of the striking results of the April 2020 INSEE consumer confidence survey. This increase goes the opposite way of the fall in the balance of opinion on price trends over the past 12 months as well as in actual inflation. This large divergence is noteworthy in view of the usual relative proximity of the three indicators. This rise in expected inflation echoes the French people’s feeling, conveyed in the media, that significant price increases have occurred since the lockdown. This is probably the consequence of the composition effect of consumption baskets and not the warning sign of a widespread and substantial pick-up in prices in the making
Since March 2020, the deterioration in the global economic environment has stopped the appreciation of the Egyptian pound. In 2019, the pound appreciated by 12% against the USD with the rise in current account receipts and sustained portfolio inflows. Since March, massive portfolio outflows have entailed the pound’s moderate 1.2% depreciation and a decline in the official foreign reserves of the Central Bank (CBE) by 11%. In the short term, current account revenues should weather the drop in Suez Canal and tourism revenues (20% of current account receipts in total). The CBE’s fx liquidity (8 months of imports of goods and services including tier-2 reserves) and the IMF financial support should allow the CBE to ease pressure on the pound in order to limit imported inflation
The Covid-19 crisis will result in a sharp contraction of eurozone GDP. However, its effect on inflation is still unclear. The impact could be disinflationary over the short term, although no consensus has emerged as to the likely medium term trend. In March, total inflation in the eurozone fell significantly, also reflecting the effect of lower energy prices. The destruction of a portion of the productive capacity could constrain supply in the medium term, whilst public policies will support demand, thus encouraging an acceleration in prices. Conversely, a lack of demand relative to potential supply could maintain a disinflationary bias in the eurozone.
Major economic policy responses have been introduced to try to attenuate the impact of the Covid-19 pandemic on the economy. This document reviews the key measures taken by central banks and governments in a large number of countries as well as those taken by international organisations. It includes measures that were introduced through 10 April. It will be updated regularly.
