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The Eurozone: inflation, stagflation, recession?


The inflationary surge since 2021 has turned into an inlflationary shock, fuelling fears of stagflation an recession. For Hélène Baudchon, however, there are reasons to temper concerns.

TRANSCRIPT // The Eurozone: inflation, stagflation, recession? : May 2022

Initially seen as transitory, the surge in inflation that began in early 2021 has turned into an inflationary shock, fuelling fears of stagflation and recession. Whilst these risks are real, there are also reasons to temper concerns. We will look at the Eurozone in particular, in order to review the growth and inflation outlook in 2022.

Let’s start with inflation, and by reminding that it continues to be driven primarily by energy prices. Indeed, in March 2022, the energy component still accounted for 60% of headline inflation (a figure that has oscillated between 40% and 60% since April 2021, with an average of 55%). Even so, inflation has kept rising, and reaching new record highs (7.4% year-on-year in March). Moreover, it is becoming more widespread, and thus more persistent. This shows up in particular in the rise in core inflation, which was close to 3% in March, itself a record high.

With high inflation driven by an oil shock, as an echo of the situation in the seventies, the word “stagflation” emerged quite rapidly. This notion of stagflation dates back to that period, combining years of very high inflation and rising unemployment. We are not there yet today: inflation is rising, but the unemployment rate is continuing to fall, at least for the time being. We cannot rule out the possibility that it will start to rise again, given the negative shocks to economic growth, but there are also sources of support that limit these concerns: the economic momentum that existed prior to the war in Ukraine, the surplus savings that could now be at least partly consumed, the pre-existing needs for investment and the new ones caused by the conflict, and the fiscal support measures in place.

More recently, the risk of recession has also made a comeback. The consequences of the war in Ukraine and China’s ‘zero-Covid’ strategy are adding to existing pressures on prices and supply chains. In the short term, it is possible that there will be quarters recording  GDP contraction, given the substantial shocks to household’s purchasing power and corporate margins alongside increased uncertainty. But, while waiting for Q1 growth figures, due out on 29 April, the second quarter has got off to a somewhat reassuring start. Indeed, the first business and consumer confidence surveys have surprised rather positively in April.

For the ECB, the trade-off is difficult between supporting growth and fighting inflation. It decided to concentrate on the latter at its 10 March meeting. Since this meeting, the way has been open to begin increasing its deposit rate. We can expect at least one, possibly two hikes before the end of the year. Timing wise, September and December seem the likeliest candidates, but the debate is mounting in favour of action as early as July. The ECB’s next meeting, set for 9 June, when it releases its new growth and inflation forecasts, will clearly be key. 

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