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Persistent inflation poses threat to eurozone recovery, economists warn


The eurozone’s economic recovery risks being undermined if persistently high inflation erodes consumers’ disposable income and forces the European Central Bank to withdraw its stimulus more quickly than planned, according to a Financial Times poll of economists.

More than 40 per cent of the 38 economists surveyed by the FT identified inflation as a significant risk to the growth prospects of the 19 countries that share the single currency — making it the most-cited risk factor for 2022 along with the pandemic.

“Inflation will eat into wages, reducing demand,” said Jesper Rangvid, finance professor at Copenhagen Business School, adding that the “ECB might also have to respond to inflation risks by raising rates, taming the [economic] upswing”.

The ECB responded to mounting concern about rapidly rising prices earlier this month by announcing its €1.85tn pandemic-response scheme would stop net bond purchases in March as part of a “step-by-step” reduction of its quantitative easing policy.

Line chart of Harmonised index of consumer prices (annual % change) showing Eurozone inflation sets new record

Inflation has risen sharply this year as the eurozone economy rebounded from the shock of the pandemic, activity restrictions were lifted and supply struggled to keep pace with demand, driving up energy costs and creating shortages of many materials. The bloc’s consumer price growth reached a record high of 4.9 per cent in November.

Like most central banks, the ECB has been surprised by the persistence of upward pressure on prices. This month it sharply raised its forecast for eurozone inflation to 2.6 per cent for 2021 and 3.2 per cent for 2022 — both above its 2 per cent target.

“Our economic outlook stands and falls with the inflation outlook,” said Katharina Utermöhl, senior economist for Europe at Allianz. “Should we see runaway inflation that looks set to remain above target also beyond 2022, then the ECB will have to rein in its policy stance much more abruptly than currently envisioned which could weigh on the real economy as well as fuel financial stability concerns.”

How did last year’s predictions fare?

Not bad, but not bold enough. Encouraged by the launch of coronavirus vaccines, economists polled by the FT predicted the eurozone economy would rebound strongly with growth of 4.3 per cent this year. They were too timid: the ECB estimates that the eurozone economy grew by 5.1 per cent in 2021, its fastest expansion for many decades.

The forecasters were also too pessimistic in most of their other predictions. Over half predicted unemployment would rise above 10 per cent for the first time in more than four years; in fact it recently fell back to its pre-pandemic level of 7.3 per cent.

Their biggest miss was inflation. On average they estimated it would be only 1 per cent this year, but it soared well above the ECB’s 2 per cent target.

The economists — who were polled by the FT before the ECB updated its forecasts this month — on average predicted that eurozone inflation would be 2.7 per cent in 2022 and 1.9 per cent in 2023. Their forecast was below that of the ECB for next year but it was above the central bank’s prediction that inflation would dip to 1.8 per cent in 2023.

“The energy price surge represents a major risk,” said Fabio Balboni, senior eurozone economist at HSBC. “[By] eating into households’ purchasing power, we have estimated it could take off 0.5 percentage points from the level of GDP over the next few quarters” which would “put the ECB in a difficult place”.

Producer prices rose 21.9 per cent in the year to October, the fastest pace since the euro was created more than two decades ago. This was mainly driven by a 62.5 per cent rise in energy prices, but even excluding that industrial goods prices still rose 8.9 per cent.

“Runaway inflation is a more significant risk [than the pandemic],” said Nicholas Bennenbroek, international economist at Wells Fargo. “Previous waves of the Covid-19 virus have typically had short-term negative effects on growth, but have not been long lasting, a pattern we expect to continue.” 

However almost half of economists surveyed thought there was still a significant economic risk from coronavirus variants.

The economists on average forecast the eurozone economy would grow 4 per cent next year, slightly below the 4.2 per cent forecast by the ECB.

André Sapir, a professor at the Université libre de Bruxelles, said the biggest challenge for the bloc was “finding the right balance for macro policy, both fiscal and monetary, to allow for a continued recovery without uncontrolled fiscal positions and runaway inflation”.

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