After two months of war in the Ukraine the fallout on euro area economic activity has been moderate so far. A first estimate reported growth of 0.2% qoq in Q1. According to PMIs the start into the second quarter was good. The composite PMI increased to 55.8 (from 54.9), a level clearly consistent with ongoing growth. This rise was driven by higher services sector sentiment which in turn largely benefitted from the unwinding of Covid stringency measures.
However, sentiment in the more export-oriented manufacturing sector sentiment receded. Persisting bottlenecks, the fallout from sanctions and new risks due to harsh lockdown measures in China are clouding the outlook. Moreover, consumer confidence plummeted and is set to fall further. Sky-rocketing inflation that reached 7.5% yoy in April. We expect headline inflation to stay around these levels over the coming months thereby eroding real incomes. And the risks are clearly tilted towards even stronger headwinds, e.g. if Russia were to completely stop gas supply to the euro area. We are looking for a protracted period of low or even negative growth.
All in all, given a poor start into the year, the Ukraine war persisting and further supply shocks increasingly likely we to our 2022 growth outlook of just 2.2%, well below the consensus expectation of 3.2%.
The ECB currently faces a perfect storm made of broadening inflation (see med-chart), huge and increasing pipeline pressure (e.g. PPI 31.4% yoy in 02/22) and inflation expectations above the 2% target. Quite noteworthy, the 5Y SPF inflation expectations (see bottom chart) rose to 2.1% for the first time. At its April meeting the ECB adopted a hawkish tone. Latest comments from Governing Council members were even more hawkish. This hardened our case that the ECB will stop QE by July. Moreover, the risks of an early start of the normalisation cycle in July increased significantly in our view.