Published: 19 January 2022
The European economy along with many was badly scarred by coronavirus but bounced back with growth of around 5.1% in 2021. For the year ahead, forecasts are for an impressive 4.5% of further gains. The rate of improvement is slowing, but the Eurozone is carrying more momentum into 2022 than some other major economies. The challenge is likely to be greater in the second half of 2022 when fiscal adjustments are required and stimulus measures are removed.
The EC’s surveys of business and consumer confidence have found economic sentiment easing and employment expectations rising further. Producer prices were 21.9% higher than a year earlier, but as with consumer prices, the ECB shows little sign of caring. Markit’s manufacturing purchasing managers’ index described “broadly stable growth… as factories battle with harsh supply headwinds”.
Last year was not an easy one in terms of COVID for the Euro Area. There have been renewed spikes in Omicron cases across many major economies, causing further restrictions and lockdowns. This all comes despite an impressive effort from European authorities to catch up on the vaccine programme. The percentage of the population fully vaccinated within the Euro Area has surpassed the United States. Even so, the renewed restrictions that carried over the end of last year will undermine growth at the start of this year.
The biggest political shift in Europe was the changeover from Angela Merkel after 16 years of being the German Chancellor. With the Social Democrats having performed best in the elections, Social Democrat Olaf Scholz took over the mantle as the new Chancellor. The cabinet running Europe’s biggest economy consists of seven Social Democrats, along with five members of the Green party and four Free Democrats (FDP). Climate change was seen as a key issue for voters during the election campaign, and this is expected to flow into EU policy as a key political topic.
There were also casualties at the end of the year with Austrian Chancellor Sebastian Kurz withdrawing from politics after allegations that he and allies used public money to pay off journalists and manipulate opinion polls.
The AUKUS deal ruffled feathers with Emmanual Macron’ nose very much out of joint. There have been some reconciliatory talks with Joe Biden, though it remains to be seen whether relations between the US and France will improve. The relations between the UK and France remain fraught, with issues around Brexit, fishing rights and migrants all leading to flashpoints.
At the beginning of 2021, inflation pressures in the Euro Area were weak. The European Central Bank met the challenge of further restrictions and lockdowns for the economy with additional rounds of asset purchases. Supply chain disruption and a robust recovery in the middle of the year led to headline inflation pressure picking up, with the rate climbing above 4% in the final quarter. The ECB now see inflation as less transitory than initially expected. They remain loathe to unwind the Pandemic Emergency Purchase Programme (PEPP) just yet.
The bank’s Chief Economist Philip Lane commented that the inflation spike “is basically part of a pandemic cycle” and “in that sense, it should not be interpreted in terms of historical norms”. He also “reiterated the official ECB stance that it would be highly unlikely for interest rates to be changed this year.”
Reasons for a rate increase will continue to build with further economic improvements and the prospect of the labour market conditions tightening. This is likely to lead to above consumer price inflation pay increases. It is unlikely that the Euro Area will suffer from sustained above-target CPI inflation because of wage growth, but the investment in environmentally friendly energy and shifts in supply chains could mean more sustained above-target inflation pressures.
The markets expect the base rate to remain at 0% in 2022, before rising to 0.4% in 2023. There is room for more monetary tightening, but, much like the Bank of England, from a reduction in the assets bought via the Pandemic Emergency Purchase Programme.
The euro had another tough quarter against the US dollar, falling from around 1.17 to lows around 1.12. The movements by the Fed to reduce asset purchases, coupled with stronger growth and employment boosted the dollar. Meanwhile the supply chain issues and covid cases in Europe point to slower growth with the European Central Bank not keen to act so far. Most forecasts look at a stablisation around current rates, though much depends on the relative courses of the two central banks.
The euro had another tough quarter against the US dollar, falling from around 1.17 to lows around 1.12. The movements by the Fed to reduce asset purchases, coupled with stronger growth and employment boosted the dollar. Meanwhile the supply chain issues and covid cases in Europe point to slower growth with the European Central Bank not keen to act so far. Most forecasts look at a stablisation around current rates, though much depends on the relative courses of the two central banks.
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Recent data shows that the UK economy regained its pre-pandemic size at the end of November. Supply disruptions, falling unemployment and rising inflation will continue to be themes for the year, with the rate hike by the Bank of England unlikely to be the last.
The US has been working on many fronts, internationally with Russia and China, and domestically with an increased fiscal spending plan. The economy has been growing strongly, prompting action from the Fed, though masses of Covid cases may halt the recovery.
Australia has been trying to return to normal with reduced restrictions and higher vaccine rates. It hasn’t been plain sailing, with current Omicron cases at record levels. The economy has been making up ground, with inflation lower than most major economies.
New Zealand is now among a small number of countries with major travel restrictions in place and relatively low levels of Covid cases. With vaccinations now at high levels, there is a path to normalisation with the central bank raising rates as inflation picks up.
The increase in oil and commodity prices has benefitted the loonie somewhat. With the potential for further rises, we could see
further strength in the first part of the year, with inflation and interest rates likely to head higher.
