Covid-19 to be disinflationary in the short-run and (mildly) inflationary in the long-run

The deep recession Europe is currently experiencing is anything but normal. T he inflation outlook therefore might be also quite different than what a “normal” recession would suggest . Unlike in “normal” recessions , the collapse in economic activity now reflects a mixture of demand and supply factors. Moreover, government s have this time come up with aggressive measures to support income. All this makes it difficult to assess ex ante with any precision by how much demand will undershoot supply, i.e. by how much economic slack will increase. Nonetheless, l atest data suggest that in the short-run , the demand effects will dominate , pointing to an easing of the underlying inflationary pressure in the coming months . The inflation outlook for the second half of 2020 depends crucially on the shape of the recovery , as this will determine the size of the output gap. We expect the economy to start recovering significantly by the third quarter and the disinflationary impact thus to be temporary. Finally, there will be more lasting developments that might turn out to be mildly inflationary that will counteract any residual disinflationary forces . Some form of further de- globalisation , for example, could directly and indirectly lead to additional inflationary pressure . Weighing up all these different factors , we expect euro area core inflat ion to ease to 1% by the summer and to hover around this level until the end of 2021.