Revising our eurozone macro forecasts and ECB view

We have changed our base scenario for the eurozone economy. We have revised upward our forecasts for GDP growth in 2022Q4-2023Q1 and have lowered our forecasts for growth during the second half of 2023. There is a number of reasons for these adjustments. To begin with, the economic impact of the energy crisis has been more benign than we thought at the end of summer, when almost all gas flows from Russia to Europe came to a halt. Indeed, there has been no rationing of gas supply to industry and global energy prices have dropped sharply in the past few months, which has also resulted in a drop in energy price inflation. Next, we had expected a rebound industrial production in the second half of 2022 on the back of the clearing of backlogs after the easing of supply bottlenecks, but this rebound has been stronger than expected, particularly in motor vehicle production in 2022Q4. This has also translated in sharp jumps in new car registrations, which will (temporarily) lift private consumption growth in 2022Q4 and probably also moving into 2023Q1. Finally, the impact of monetary policy tightening famously works with long and variable lags and we judge that most of the cumulative impact of past and upcoming rate hikes and tightening financial and bank lending conditions is still very much to be felt on the economy. As a result, we now forecast a more shallow, but more prolonged recession, with GDP contracting modestly during four consecutive quarters, starting in 2022Q4. Average growth in 2023 is expected to be -0.3%, versus our earlier forecast of -0.9%. Our growth forecast for 2024 has been lowered to 0.9%, down from 1.2%. Although the tightness of the labour market could result in some labour hoarding and loss of productivity during the first two quarters of the recession, we expect the unemployment rate to start rising gradually as from around the second quarter of 2023 onwards. This rise in unemployment (and lower inflation) should weigh on wage growth during the second half of this year and in 2024. Though wage growth will probably accelerate noticeably in the coming months.

We have lowered our forecast for headline inflation in 2023 to 4.5% from 5.1% and we expect inflation to fall back into line with the ECB’s 2% target by the end of this year. Core inflation is expected to be more sticky and decline more slowly than headline inflation and we expect core inflation to be higher than the headline rate in the final months of this year. We see core inflation at around 2.5% in the final months of 2023, but it should also fall gradually towards 2% in the second half of 2024.

ECB to continue raising its policy rates until May, with a peak of 3% for the deposit rate

Given the more resilient recent macro data, we think the bar for the ECB to end its rate hikes earlier than it currently plans has risen. We therefore now expect the ECB to continue raising its policy rates until May, with a peak of 3% for the deposit rate (from 2.75% previously). This assumes that a 50bp move next month is followed by 25bp steps in the two subsequent meetings (though a solitary 50bp step in March is clearly also a possibility). The ECB’s staff macro projections assumed a rate of around 3% and on this basis saw inflation finally reaching and settling at the 2% target from around the middle of 2025. This might not be timely enough for many Governing Council members, and a quicker return to target would imply that policy rates may need to rise to above 3%. However, despite the recent revisions, we are still more cautious than the ECB on the growth outlook, and much more constructive on inflation. Given this, we think that policy rates will peak lower than the ECB currently has in mind, while policy rate cuts will be on the agenda before the end of the year (again contrary to the central bank’s current guidance). Rate reductions would start the process of normalising policy back to more neutral settings in 2024.