Frederik Ducrozet, Head of Macroeconomic Research, Pictet Wealth Management.

Higher inflation, weaker growth, larger deficits and faster rate hike

We are revising our euro area GDP forecast to account for a more severe energy shock and deeper winter recession than previously foreseen. We now expect annual GDP growth in the euro area to fall from 2.9% in 2022 to 0% in 2023.

We have yet to see the peak in euro area inflation. Headline inflation is likely to top 10% by Q4 2022, increasing the risk that core inflation will also stay higher for longer, hovering around 4% going into next year.

National governments will likely implement new support measures to mitigate the impact of the energy shock on real incomes, but inflation may prevent a bolder policy response, or European fiscal transfers for that matter.

The ECB has no choice but to commit to faster monetary tightening as long as inflation keeps rising. The latest policy signals from Jackson Hole suggest that the ECB is placing more weight on actual inflation outcomes than on staff projections, making a 75bp hike more likely in September.

However, policy normalisation will be bumpy and a ‘stop-and-go’ approach looks increasingly possible. This means the ECB could pause when recession hits by the start of 2023, but resume hiking rates once the economy recovers later next year.