Roaring reflation no reason to flinch

Despite the roaring return of inflation in H2 2021, the ECB should not flinch at next week’s policy meeting. In particular, it should refrain from taking an unneccesary bet on how the pandemic, the economy and yields (and in turn US monetary policy) will develop over the next quarter by pre-committing to a lower PEPP purchase pace. First up, the ECB will present a new set of macroeconomic forecasts next week: Thanks to a stronger-than-expected Q2 rebound – notably in the Eurozone periphery in contrast to a disappointing growth performance in core economies – the ECB is likely to marginally upgrade its 2021 GDP forecast closer towards +5% (broadly in line with our own). The focus, however, will be on any adjustments to its 2022 Eurozone GDP forecast as it will provide some insights into the ECB’s assessment of the recovery’s strength. We expect the ECB to take a more cautious stance on the outlook for next year, reducing its current forecast of +4.7% closer towards +4% while broadly maintaining its 2022 forecast. This reflects to some extent a more front-loaded recovery in 2021. At the same time, though, upside potential for 2022 is capped by lingering downside risks, including the fresh rise of Covid-19 cases across Europe – which could well weigh on investment and consumption plans even in absence of renewed lockdowns – as well as persistent supply challenges that threaten to clip the wings of the industrial recovery. 

As far as inflation is concerned, the recent upside surprises in the HICP (+3% y/y in August, fueled by supercharged base effects and one-offs) certainly call for an upward revision to the ECB’s 2021 forecast. More interesting will be the ECB’s inflation forecasts for 2022-23 since they will give an indication of whether the ECB still categorizes the current inflation overshoot as largely transient. We expect no major adjustments to inflation forecasts and expect them to remain firmly below 2%.

These adjustments in the macroeconomic projections would represent no game-changer for the monetary policy outlook. If anything, elevated uncertainty about the strength of the recovery, particularly at the turn of 2021/22, would justify prolonged policy support, which according to our analysis the ECB can well afford to extend, given the inflation outlook. 



Patrick Krizan
Allianz SE