This commentary by Martin Wolburg, Senior Economist at Generali Investments, discusses the situation in the Eurozone, where they see a recession in the second half of 2022 that will affect Germany significantly, as it will last in Germany until 2023.
The euro area outlook clouded further. A nasty mixture of ever new inflation highs with a July reading of 8.9% yoy and the announcement of Russia to cut gas supply to a low level (of North Stream 1 to just 20%) for the time being are the key reasons. On top, the economic environment also worsened with the US already in a technical recession most noteworthy. The July composite PMI dropped to 49.4, implying a contraction of growth by -0.1% qoq. Forward-looking indicators like new orders and economic expectations deteriorated strongly across the board. Quite outstandingly, consumer confidence fell even below the pandemic trough in April 2020.
Looking ahead, we now deem it most likely that (at least) temporary gas shortages will induce production shortfalls. We are also sceptical whether households are willing to reduce their savings rate much further (latest available Q4/21: 13.7%) including Covid-related excess savings. We also see the need to revise our 2022/23 inflation forecasts further up to 7.8%/4.4%. All in all, we now make a H2/2022 recession with mildly negative growth our base case. Following a 2022 annual growth rate of 2.9% amid a surprisingly strong (flash) output growth of 0.7% qoq in Q2/22, activity is set to decelerate strongly to just 0.8% in 2023.
Germany will be hit hardest and we expect its recess-ion to last into 2023 bringing annual growth down to 1.1% in 2022 and make it with -0.1% even negative in 2023. The ECB surprisingly hiked its key rates by 50 bps lifting the depo rate to zero in July, maintained a hawkish tone but left the future path of policy rate deliberately open. With headline inflation likely coming close to 9% yoy, medium term inflation expectations (see bottom graph) above target and the neutral policy range (1% to 2%) not yet in sight, there is plenty of leeway for further hikes. However, with the economy in recession the urgency of rate hikes falls. In sum, we stick to our year-end key rate forecast of 0.75% but see the risk now more balanced.