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EU raises inflation forecasts on supply disruptions, energy crisis

Visitors attend a live performance from a jazz band following the removal of coronavirus restrictions, in Gothenburg, Sweden.

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Inflation in the euro area is likely to move below the European Central Bank’s target of 2% next year despite recent surges in consumer prices, new forecasts have shown.

The debate over inflation in the 19-member bloc is fierce. On the one hand, some argue that current inflationary pressures will ease and a degree of loose monetary policy is needed. Others counter that the ECB needs to tighten monetary policy after consecutive historic monthly highs in inflation.

Bundesbank Governor Joachim Nagel became the second central banker in the last few days to indicate that the ECB may raise rates later this year.

However, the European Commission, the executive arm of the EU, said Thursday that inflationary pressures are likely to come down next year.

“After reaching a record rate of 4.6% in the fourth quarter of last year, inflation in the euro area is projected to peak at 4.8% in the first quarter of 2022 and remain above 3% until the third quarter of the year,” the commission said in a statement.

“As the pressures from supply constraints and high energy prices fade, inflation is expected to decline to 2.1% in the final quarter of the year, before moving below the European Central Bank’s 2% target throughout 2023,” the institution added.

As such, the commission estimated that annual inflation in the euro area will rise from 2.6% in 2021 to 3.5% in 2022, before then falling to 1.7% in 2023.

These numbers, however, point to an upward revision in the ECB’s own inflation forecasts at its next meeting in March.

Market participants will be closely following the meeting to understand whether the ECB will cut its bond-buying program or adjust any other terms of its policy. Whatever the central bank decides to do could have a massive impact on the recovery of the euro zone economies, some of which were particularly hit by the pandemic.

High uncertainty

The outlook for inflation, but also for the overall economy in Europe, is also dependent on tensions between Ukraine and Russia.

“Risks to the growth and inflation outlook are markedly aggravated by geopolitical tensions in Eastern Europe,” the commission said in a statement.

Speaking to CNBC last month, Eurogroup President Paschal Donohoe also warned that these geopolitical risks could have a significant economic impact.

Europe is highly reliant on natural gas from Russia, some of which arrives via pipelines in Ukraine. Any escalation in the tensions could impact the usual flows of gas and push up costs, which would drive inflation even higher.

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