European Central Bank expectations for the Eurozone economy remain subdued as Christine Lagarde, the ECB’s president, warned on Monday that economic activity will slow significantly in the months ahead. With wage growth showing limited momentum, she noted that a modest recovery could offset weaker labor-market resilience and persistent inflation, which could push wage increases higher.
In her third appearance this year before the European Parliament’s economic affairs committee, Lagarde highlighted the economy’s midyear strength, driven by robust consumer spending on services as restrictions ease, a thriving tourism sector, and a still solid labor market. Yet she cautioned that activity is likely to slow markedly in the coming quarters. The ECB attributes this outlook to elevated inflation that dampens overall spending and production, along with reductions in gas supplies.
Additionally, the surge in demand for services linked to reopening gradually weakened. Slower global demand and deteriorating terms of trade amid tighter monetary policy in major economies are expected to provide less support for the euro area. Heightened uncertainty has also weighed on both households and firms. As a result, the latest ECB projections lowered growth: 3.1% in 2022, 0.9% in 2023, and 1.9% in 2024 under the reference scenario. Lagarde stressed the difficulty of predicting the 2023 outcome given ongoing budget-policy uncertainties, calling the year very challenging.
More rate hikes
Nevertheless the ECB intends to keep raising interest rates at upcoming board meetings, following increases of 0.5 percentage points in July and 0.75 percentage points in September. The aim is to continue cooling inflation pressures. The central bank signaled that further rate increases are likely in the coming meetings to curb demand and shield against persistent upside risks to inflation expectations. The October meeting will proceed with data-driven decisions as uncertainty remains high.
Lagarde reiterated the central bank’s stance on the real-world impact of rate hikes, acknowledging their effect on mortgage costs while underscoring the necessity of the policy path. She noted that inflation had reached a peak of 9.1% in August, with energy and food acting as primary drivers. Pressure has since spread to additional sectors due to the broad impact of higher energy costs on the economy.
Inflation trajectories
ECB researchers project annual inflation at 8% for 2022, 5.5% for 2023, and 2.3% for 2024, still above the 2% target. The chief risks to the inflation outlook lean upward, reflecting the potential for further energy-supply disruptions. While similar risks apply to growth, their effects tend to reinforce inflation while dampening expansion. Lagarde stressed the importance of maintaining a balanced policy stance in the face of these divergent forces.
In her remarks, the ECB president also addressed measures to counter fragmentation within the euro area. The Transmission Protection Tool, introduced last July, is designed to counter erratic and unfair market dynamics with enough flexibility to address transmission risks. Asked about using the tool with Italy, Lagarde said there was no country-specific plan and affirmed the objective of ensuring adequate transmission across all eurozone members. Four criteria would guide any deployment: adherence to the budget framework, absence of significant imbalances, budget sustainability, and sound macroeconomic policies.