The eurozone economy came to a near-standstill in the third quarter as inflation surged above all expectations to top 10 percent for the first time, preliminary Eurostat data showed on Monday.
The toxic combination of weak growth and surging prices points to dark winter months ahead.
Inflation surged to 10.7 percent from 9.9 in September and was significantly higher than the median forecast in a survey of analysts ahead of the data release.
Price pressures continue to be driven primarily by skyrocketing energy prices, which were up 41.9 percent on the year, compared with 40.7 percent in September. However, there were also clear signs of higher energy prices seeping through to the broader economy.
Core inflation, which strips out volatile components of energy and unprocessed food, rose to 5.0 percent from 4.8 percent in the previous month, suggesting underlying price pressures are continuing to build.
“The inflation rate has probably still not reached its high point,” said Commerzbank economist Christoph Weil, noting that inflation was “significantly higher than expected” as prices rose “strongly across the board.” He thinks inflation could top 11 percent by year-end.
Inflation continued to race ahead in the Baltics, hitting 22.4 percent in Estonia, 22 percent in Lithuania, and 21.8 percent in Latvia. The lowest inflation rates were recorded in Malta (7.5 percent) and Finland (8.3 percent).
The historic price surge has left deep marks on economic activity in the third quarter, even if it remained more resilient than feared ahead of the release of national data late last week. The eurozone economy expanded by a mere 0.2 percent, after growing a robust 0.8 percent in the second quarter.
Looking at regional developments, the economy shrunk in Latvia (-1.7 percent) and in Austria and Belgium (both -0.1 percent), while Italy posted surprisingly strong growth of 0.5 percent.
Most experts expect the region to fall into recession over the winter. Last week, a key ECB survey showed participants forecasted growth to be negative between the third quarter of 2022 and the first quarter of 2023 with a cumulative decline of 0.7 percent. For 2023, they expect the region to essentially stagnate with 0.1 percent growth.
“With high-frequency data in negative territory, it is a matter of how deep the recession will be and not if there will be one,” said Oxford Economics economist Nicola Nobile after the release of the data. “Therefore, while Q3 was more resilient than expected a recession over the winter in the eurozone is imminent.”
ECB Governing Council member Olli Rehn even raised the specter of stagflation — that is a prolonged period of slow growth and high inflation which Europe last experienced during the 1970s. “There are first signs of stagflation to be seen,” he said in an interview with Finnish media released Monday.
Inflation exceeding expectations once again will boost the case for more aggressive monetary policy tightening. Higher interest rates, in turn, are set to further weigh on economic activity. “Today’s data increase the likelihood that the ECB will raise its key interest rates again by 75 basis points in December,” Weil said.
Hawks on the Governing Council leave no doubt that price stability consideration will top growth concerns when setting policy. “We will take a significant interest step again in December,” Dutch Governing Council member Klaas Knot told Dutch TV over the weekend. “We are not in even half-time yet,” Knot said of the ECB’s fight against surging inflation, adding the scope of the next rate hike will be between 50 and 75 basis points.
President Christine Lagarde also sent a clear message over the weekend. Her new language on souring growth prospects during last week’s monetary policy press conference had largely been viewed as dovish, prompting markets to scale back interest rate hike expectations. Yet after much stronger than expected national inflation prints Friday, Lagarde tweeted, “defeating inflation is our mantra, our mission, our mandate.”