December 1, 2023


FRANKFURT — Just a few months ago, everyone was worried about inflation – except the European Central Bank. Today, everyone fears that the Ukraine invasion will massively hit European economic growth — except the ECB.

What’s prompting the ECB to play the optimist again, putting it at risk of having to play catch-up?

“Still wonder what happens once the ECB finds out that the war in Ukraine will not only push up inflation but will also weigh heavily on growth,” ING economist Carsten Brzeski quipped on Twitter, following the ECB’s latest release of forecasts.

Before the Russian attack on February 24, the ECB expected the eurozone would grow by 4.2 percent this year and 2.9 percent next year. Those growth prospects were solid enough that its policymakers started to shift gears in December to focus on fighting inflation.

ECB staff forecasts now include three different scenarios for growth, in recognition of the exceptional uncertainty. The baseline scenario sees GDP growing 3.7 percent this year and 2.8 percent in 2023. An adverse scenario sees growth at a more muted 2.5 percent this year and 2.7 percent next, while an even more adverse scenario puts growth at 2.3 percent for both years.

But outside the central bank, analysts paint a much bleaker picture. Projections from top banks tend to be closer to the ECB’s adverse or even severe scenario.

Barclays, for instance, sees GDP at 2.4 percent this year and 2.1 percent next year, while Goldman Sachs took it a notch higher, to 2.5 percent and 2.2 percent, respectively. Forecasts by Natixis, Morgan Stanley and Société Générale are more optimistic, pegging growth to around 3 percent this year, but that’s still well below the ECB’s baseline estimate.

As for JP Morgan, “we have made a significantly bigger growth revision, and our forecast is now significantly below that of the ECB staff’s,” said economist Greg Fuzesi, noting their estimate still hadn’t incorporated the latest gas price levels.

Some of that discrepancy may be attributed to the February 28 cut-off for the ECB’s forecast. ECB Governing Council member Ignazio Visco hinted at that when he told a conference last week “there are grounds to believe” that the ECB’s latest projections “are already outdated.”

However, ECB President Christine Lagarde continues to reference projections without suggesting a significant revision is in the cards.

“I believe that today, at least on the basis of the scenarios we have developed and given the strong economic recovery in which we find ourselves in the current cycle, we do not currently see any elements of stagnation,” Lagarde said Monday. Even in the adverse scenario, which assumes second-round effects on inflation and a boycott of Russian gas and oil, growth is still seen at 2.3 percent, she noted.

Look on the bright side of life

Barclays economist Silvia Ardagna chalks up some of these differences to the fact that the ECB projections were finalized when “it wasn’t clear whether Russia’s aggression was a short-lived attack or drawn-out war, [and] it wasn’t clear whether sanctions would be scaled up or down.”

Société Générale economist Anatoli Annenkov, for his part, ascribes the difference between his bank’s forecast and the ECB baseline scenario largely to different assumptions on oil prices. But he’s surprised by how narrow the difference is between the ECB’s worse and worst cases, calling it “quite revealing.”

“Even under the severe scenario, with a massive rise in inflation, the economy is growing above potential,” he pointed out. In other words, the ECB may be overestimating growth.

The severe scenario for 2.3 percent also had former ECB Executive Board member Peter Praet scratching his head, given that this scenario doesn’t assume a significant boost in fiscal spending to cushion headwinds.

Praet, who was in charge of putting together staff projections when he worked as chief economist at the central bank, noted that, more broadly, “the forecasting models tend to underestimate the impact of higher uncertainty on consumption and investment,” he added.

Another explanation is more political: The ECB remains focused on its mandate to control inflation and doesn’t want to muddy its message.

“The ECB feels the need to sound more positive on growth given that they have a real inflation problem,” Annenkov suggested. “They need to stick to plans of withdrawing stimulus to anchor inflation expectations, while hoping to avoid recession.”

Behind closed doors, meanwhile, other European officials see darker outcomes.

The European Systemic Risk Board, which is chaired by Lagarde, warned in a presentation to EU capitals in Brussels last Wednesday that the war’s effect could be “much larger than currently expected” due to supply-chain disruption and higher prices for households and firms.

Such a scenario would make the ECB’s job of tightening policy to fight rampant inflation even tougher. The central bank currently sees eurozone inflation averaging 5.1 percent this year — a forecast that most analysts view as too benign.   

In the near term, the odds are the economic hit will be “huge and probably much greater than presently being forecasted by most,” warned UniCredit economic adviser Erik Nielsen.

He’s particularly concerned over the longer-term impact.

“The war will cause a much more profound shock to the global economy than the pandemic did,” he said. “The fire is not coming through the front door, but it will burn longer. It would take a miracle for there not to be a return of Cold War relations between Russia and the West.”

“And there are real risks things become more dire in case China is forced to take sides or the war escalates,” he added.

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