Eurozone

However, certain factors have led the European Central Bank (ECB) to believe that the rise in inflation is a temporary phenomenon that will not require an increase in interest rates. First, since inflation rates are calculated by comparing the current price level against the price level a year ago—low prices in 2020 due to low demand and various policy measures to check the economic impact of the pandemic might have distorted the current inflation rate upward. Germany, for example, lowered its value-added tax in 2020, which means the benchmark for calculating inflation rates in 2021 was lower, leading to an artificial price increase. Second, there is reason to assume that energy prices will not rise at the same rate as last year, reflecting expectations that oil demand and supply might reach a balance, although this is hardly a certainty.⁴ As a consequence, the ECB intends to continue its ultra-loose monetary policy and, unlike the Fed, has ruled out interest rate increases for now. The only change in monetary policy to be expected is a slower pace of the bond-buying program. Nevertheless, in December, as a reaction to current inflation figures, the ECB almost doubled its inflation forecast for 2022 to 3.2%, but it expects a decline in the following years.⁵

Role of labor markets and wage rises

How inflation evolves going forward and, specifically, whether it tapers off in the coming years or not will depend to a large degree on the labor market and wage pressures on inflation and supply chains. Supply-chain interruptions are likely to start ceasing in the second half of 2022. First, because of pent-up demand, consumers will likely shift their expenses to services once economies open again, thus easing pressure on supply chains. Second, there are signs that transportation challenges are abating and will continue to do so over the course of the year.⁶ Clearly, the key to both these scenarios becoming a reality is that the current wave of COVID-19 is brought under control by spring.

What the recent trends in the labor market lead to is even more uncertain, and as such, labor markets remain one of the most important areas to keep an eye out for in 2022. The strategy to retain jobs through furlough schemes by many countries in the Eurozone proved successful. At 7.2% in December 2021, unemployment is exactly at the same level as in February 2020, that is, before the onset of the pandemic.⁷ At the same time, labor shortages have reappeared. In Germany, for example, CFOs see labor shortages as the most critical risk to their businesses for the next 12 months, according to the Deloitte CFO survey.⁸ The picture in many other Eurozone countries is similar.

If labor shortages persist and result in wage rises, inflation pressures could become more structural, further driving prices. While wage pressures have been modest so far, it is to be expected that unions—whose bargaining power is supported by current labor shortages—will likely incorporate current inflation rates into their wage demands for the upcoming bargaining rounds in 2022. The central role of these collective wage-bargaining rounds in many European countries will likely have strong signaling effects even for the nonunionized sectors.

Meanwhile, several Eurozone countries such as France, Belgium, and Portugal increased their minimum wages, partly as a response to the surge in inflation. Most notably, the new government in Germany raised the minimum wage by more than 25% to 12 euros. ING Research, on the back of these trends, expects a rebound of wage growth in the range of 3–3.5%.⁹The risk of a wage-price spiral and a persistence of inflation pressures are therefore non-negligible.

The baseline scenario

The risks posed by a possible entrenchment of inflation, longer-than-expected continuation of the current wave of COVID-19, and political developments such as the ongoing tensions at the Ukrainian border need to be closely monitored as these risks have the potential to derail the recovery in the Eurozone.¹⁰ However, if these risks do not materialize, the Eurozone could find itself on a dynamic growth path thanks to the presence of several tailwinds in its favor.

First, the investment appetite of European corporates is high, as evidenced from the findings of the autumn edition of the Deloitte European CFO survey.¹¹ Capital spending is thus likely to become an important driver of the recovery. Second, the enormous backlog of orders from 2021 in the industrial sector should lead to a rebound in output once supply chains start to work more seamlessly. Third, and most importantly, consumers are sitting with a substantial excess savings: Eurozone households still have around 350 billion euro of more savings than they had before the crisis, according to calculations from Deloitte Research.¹² This money is likely to be spent incrementally once the current wave of COVID-19 begins to tail off. The services sector, in particular, should benefit from the combination of pent-up demand and consumers’ massive spending power. Furthermore, as was the case in 2021, private consumption will continue to be the key driver of growth in 2022.

To sum up, the Eurozone, in the absence of the aforementioned risks, is likely to witness a substantially above-trend economic growth. The growth, however, will be subdued in the first quarter due to the current Omicron-driven wave of COVID-19. In fact, the economy will likely come close to stagnation; in some countries such as Germany, even a technical recession is possible. Nevertheless, we believe that growth should return in the second quarter and accelerate afterward, resulting in a growth rate of a little less than 4% in 2022. GDP, meanwhile, is expected to reach prepandemic levels by the middle of the year.