The ECB sees inflation pressures as temporary and is unlikely to raise interest rates.
The eurozone economy has outperformed consensus estimates as it grew by 2.2% quarter-on-quarter in Q3, matching the previous quarter. This leaves the level of economic activity just 0.5% below its pre-pandemic peak, meaning that the recovery in GDP should be complete this quarter (Q4).
Whilst the aggregate eurozone GDP figures surprised to the upside, the results within the major member states were more mixed.
France provided the biggest upside surprise, growing by 3% compared to consensus expectations of 2.1% growth, and 1.3% growth from Q2 (revised up from 1.1%). This was thanks to a strong rise in household consumption, which was helped by the further easing of pandemic-related restrictions and an improvement in consumer confidence.
Elsewhere, Austria also beat expectations with 3.3% growth, down from 4% in the previous quarter. Italy provided the other significant upside surprise, growing by 2.6% in Q3, only slightly down from 2.7% from the previous quarter.
In contrast, Germany disappointed the consensus as it grew by 1.8%, down from Q2 growth of 1.9% (revised up from 1.6%). Although 1.8% quarterly growth is still high by historic standards, it is clear that supply bottlenecks have hampered the recovery in Germany’s manufacturing sectors. The level of German GDP is still 1.5% below its pre-pandemic peak, compared to France which is just 0.1% below.
A concern for Germany is that it may have missed its chance to take advantage of the strong recovery in global demand for goods. For months, new orders have outpaced output, causing a major backlog, depleted inventories and long delivery times. Companies appear to have responded by raising their prices, though part of this will have also been driven by the higher cost of raw materials.
In the latest data from business surveys, it appears that demand is now fading, reducing the potential upside for German manufacturers. This may be partly due to weakness externally, especially in China and Asia, but it may also be due to a loss in competitiveness, which is more concerning.
Spain saw activity accelerate from 1.1% growth in Q2 to 2% in Q3, but this was below consensus estimates of 2.7%. Though some tourism returned during the quarter, it appears that delays in lifting restrictions may have contributed to the disappointment. Spanish GDP remains 6.6% below its pre-pandemic peak, highlighting the challenge ahead to return to normality.
Energy costs push inflation to a 13-year high
Meanwhile, flash inflation figures released today show headline eurozone inflation reached 4.1% y/y – the highest rate of inflation since July 2008. Energy inflation reached 23.5% y/y, contributing 2.1 percentage points to the headline rate. This was caused by the recovery in wholesale oil and gas prices which fell sharply last year during the height of the pandemic.
Worryingly, energy inflation is likely to rise further, and persist for longer as oil prices have risen further. More significantly, there has been a major spike up in wholesale gas prices.
Core inflation, excluding energy, food, alcohol and tobacco rose from 1.9% to 2.1%. While much lower than the headline rate, it is still high by historic standards. However, about a quarter of this is cause by the reversal of the German VAT cut from 2020 at the start of this year. The distortion will drop out of the annual comparison in January 2022.
Challenges ahead will keep monetary policy loose
Overall, the latest growth figures are broadly positive and point to an ongoing recovery, particularly in services sectors which were badly impacted by the pandemic. However, there are growing concerns that external demand for goods is fading, especially in response to rising prices which are mostly caused by supply bottlenecks.
Meanwhile, inflation is expected to rise further, potentially denting consumer confidence, and reducing the contribution from household spending, which is expected to be the biggest driver of growth in 2022.
For the European Central Bank (ECB), the message following the October meeting was loud and clear that the governing council sees good progress being made in the recovery, but that there is further to go. The ECB kept all policy unchanged and provided a cautious but optimistic message on the outlook.
The ECB warned of higher inflation on the horizon, but it sees most of the factors driving prices as temporary. They are mostly caused by temporary distortions (German VAT) and external factors (wholesale energy) which should dissipate by the end of next year.
The ECB is set to end the portion of its quantitative easing programme related to the pandemic by the end of March next year. But it is expected to keep some other purchases going beyond March and it is clearly not ready to raise interest rates anytime soon.
