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Infocus - Inflation has surged to levels not seen in decades due to rising commodity prices, supply chain bottlenecks and tight labour markets. These factors apply to most developed countries, but not to Switzerland where inflation remains low. In this edition of Infocus, GianLuigi Mandruzzato compares Swiss inflation to that in the US and the eurozone and draws some policy implications.
The eurozone economy is in recession. The energy crisis and resulting high inflation have eroded private sector purchasing power and monetary policy tightening has further weighed on growth. While inflation is high, several factors suggest that it may soon decline sharply. In this edition of Infocus, GianLuigi Mandruzzato looks at the possibility that a deep eurozone recession leads to a quick fall in inflation.
Having been surprisingly strong in the first part of the year, the eurozone economy probably fell into recession over the summer. Since July, the composite PMI index, which summarises activity in the manufacturing and services sectors, has remained below 50, the threshold that signals that economic output is contracting (see Figure 1).
Although the composite PMI level is only slightly below 50, its trend up to October points to a deteriorating outlook (see Figure 2). New orders declined more than output, reflecting the energy crisis, the lockdowns in China and tightening financial conditions. The composite PMI could fall towards 40, a level recorded only after the collapse of Lehman Brothers in 2008 and during the covid pandemic. Overall, there is a high risk that GDP will drop significantly in 2022Q4 and that the contraction will also continue in early 2023, reducing next year’s GDP growth to around zero.
The risks to growth are evident when looking at household confidence. According to the EU Commission’s consumers’ survey, the willingness to buy durable goods is at the most depressed level since the series began in 1985, reflecting the impact of increased prices of basic goods and services on households’ purchasing power (see Figure 3). Furthermore, consumers fear a worsening of the labour market. Finally, the recovery in tourism after the ending of Covid restrictions is largely complete and will provide less stimulus to the economy than in the first part of 2022.
Economic growth will also be constrained by tighter ECB policy. Rate increases of 1.25% between July and September will fully impact growth by mid-2023. Growth will be further restrained by any interest rate increases from October onwards: market participants are expecting rates to reach 3.25% by 2023Q3 (see Figure 4).
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