Strong rebound and temporary rise in inflation

The euro-zone is on the way to an almost full recovery. We expect Germany to regain its pre-pandemic level of activity later this year and the tourist-dependent southern countries to do so next year. The Delta variant may lead to some voluntary social distancing or self-isolating and perhaps limited restrictions over the winter, but we doubt that it will derail the recovery. Inflation will rise further than most expect in the coming months due to rising input costs and supply bottlenecks. But with wage agreements and inflation expectations remaining low, it will drop back and stay lower than most expect over the medium term. The ECB is likely to step up its standard Asset Purchase Programme substantially when its emergency purchases end next March and leave its deposit rate at -0.5% until beyond 2025, which is much later than investors expect.

16 July 2021

ECB to keep pushing on a string

We expect economic growth to remain sluggish this year as external demand picks up only slowly and domestic demand softens. Employment growth is slowing, which will cause household incomes and spending to weaken, and investment intentions have slumped. Germany’s industrial recession looks set to persist during the first half of the year, and its services sector to lose momentum. Meanwhile, Italy is still close to recession, but France and Spain should continue to outperform. We suspect that core inflation will drop back to around 1% over the coming months, prompting the ECB to ease policy in the second half of the year.

21 January 2020

Eight quick points about the European elections

Projections of the results of the European elections confirm that pro-European parties will continue to have a clear majority in the European Parliament (EP) itself, so little will change at EU level. But there will be some fallout for national politics, notably in Italy and Greece.

27 May 2019
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Missing the global tightening cycle

The euro-zone should regain some momentum in the coming months, at least compared to its dire performance at the end of last year. But we think the economy will expand by just 1% in 2019 as a whole. Demand in key export partners is set to slow further, particularly if we are right in expecting the US economy to lose steam later this year. Business investment has come off the boil and will be held back by the weak global backdrop. And household consumption looks set to increase at only a moderate pace, despite the drop in energy prices, because consumer confidence has fallen and households are likely to increase their savings. All of this means that core inflation will stay close to 1%, rather than converging towards the ECB’s target, and that policymakers will leave interest rates on hold this year and next – missing the global tightening cycle completely.

Outlook has brightened despite political risk

The euro-zone has continued to perform very well and we now expect growth to be stronger than the consensus forecast this year and next. Inflation has been lower than we had assumed, meaning that household spending growth should not slow too sharply. Meanwhile, business and consumer sentiment have been resilient to political uncertainty and we expect this to continue, albeit with downside risks related to shock electoral outcomes. The UK should continue to weather its own political turmoil while the particularly strong performance of the Swiss and Nordic economies is likely to see their currencies strengthen further. We expect the first interest rate hikes to come in Sweden later this year, followed by the UK in 2018. But the European Central Bank will lag behind as remaining spare capacity in the labour market keeps euro-zone inflation pressures subdued.

Crisis 2.0?

The onset of deflation in the euro-zone and the recent developments in Greece have served as powerful reminders of the lasting effects of the region’s debt crisis. The ECB will seek to tackle deflation with additional monetary stimulus in the form of quantitative easing. But it is far from clear that it can prevent a Japanese-style prolonged period of weak activity and flat or falling prices. Meanwhile, Greece’s problems have highlighted the political and economic challenges still facing the periphery’s highly indebted economies. Against this background, there is a clear danger that the euro-zone crisis re-ignites, casting renewed doubts on the future of the currency union.


Stalled recovery adds to pressure on policymakers

The European economic recovery has weakened, with the euro-zone now at risk of recession and countries outside the region feeling the effects on their exports. While the euro-zone’s peripheral countries are making some encouraging fiscal and economic progress, conditions in the region’s core have deteriorated markedly and even Germany is now struggling to grow. But EU authorities remain reluctant to loosen the fiscal restraints on indebted governments and calls for a fiscal boost in Germany have so far fallen on deaf ears. We expect the ECB to submit to pressure for full-blown quantitative easing soon, but its support will be limited by ideological and political constraints.

As good as it gets?

While the European economic recovery probably picked up a bit of speed in the second quarter of the year, there are growing signs that Q2 was as good as it is likely to get. Activity indicators in the euro-zone have softened again in the last few months, with even the recovery’s main engine – the German industrial sector – losing steam in the face of weak demand and the strong euro. Against this background, inflation looks set to remain at very low rates in the currency union, hindering fiscal consolidation efforts in the indebted economies and sustaining the threat of a Japanese-style bout of deflation in the absence of more decisive action from the policymakers.


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