Euro area inflation outlook: does the old rulebook still apply?

The euro area is hit by a wide range of cost shocks that have pushed headline inflation close to record highs. While t his is certainly not the first time the economy is exposed to cost shocks , the magnitude and the underlying causes for the price shock s are unusual and may have the potential to kickstart a more lasting rise in inflation. Based on past behaviour one would expect all the second-round effects of the initial price shocks to gradually peter out over the course of next year. But economic patterns and correlations can change and there are several factors that could lead to a different structure of the post-pandemic economy – and different inflation dynamics . Global supply chains, for example, may have been permanently damaged or the labour market may turn out much tighter than the unemployment rate would suggest. That said, we don’t find any evidence that the euro area economy is undergoing a transformation that would pave the way for a more inflationary environment. We therefore still expect headline inflation to peak by in the end of this year. However, the latest surge in natural gas prices implies that the decline will be much more gradual than we previously thought, and we expect inflation to decline below 2% only by the middle of next year.