A key reason for the ECB’s pivot towards a more hawkish stance, and the sharper turn in Vanguard’s forecasts: Inflation is rapidly spreading throughout the economy, beyond the volatile food and energy components that are directly impacted by Russia’s invasion of Ukraine.
“Three months ago, 40% of the basket of goods and services witnessed inflation rates that were 2 percentage points above the historical average,” Spitznagel said. “It’s now 60% of the basket.
“Services inflation has accelerated to its highest point since the euro’s introduction in 1999,” she noted. “That’s the more persistent part of inflation. Once that increases, the harder it is to bring inflation back down.”
There’s also the danger of a wage-price spiral: Higher prices push up the demand for higher wages, and firms in turn protect their margins by passing on the higher labor costs to consumers through higher prices. Wages are already rising in Europe, though at a more muted pace than in the United States.
“And then there are other inflationary pressures—a weaker euro and larger-than-expected supply bottlenecks stemming from China’s dynamic zero-COVID strategy,” Spitznagel said. “All of this has led us to upgrade our inflation forecast for calendar 2022 from an average in the range of 6.5%–7% to 7.5%–8%. We expect inflation in Europe to reach a peak of close to 9% in the third quarter of this year.”