Francesco Canepa and Balazs Koranyi

FRANKFURT, (Reuters) – Euro zone sentiment fell more than anticipated last month and inflation reached a new record high. This indicates that the economy is experiencing renewed stress due to rising coronavirus infections forcing governments to tighten their restrictions.

Omicron infections are breaking records nearly daily across Europe. This means that growth will likely take a dip around the beginning of the year, even though governments have avoided some of the debilitating measures which brought down their economies a year earlier.

The pain was reflected in the European Commission’s Economic Sentiment Indicator. This indicator is a crucial gauge of economic health and performance. It fell sharply in December, more than expected, to levels last seen in May. Employment expectations and the outlook on services were also affected by the decline in service.

Hard data already shows that Germany is the largest economy in the Euro Zone, and the slowdown has begun.

For most of the past quarter, Germany’s huge factory sector was held hostage by supply chain bottlenecks. Industry, which had been expected to rebound in the third quarter, unexpectedly fell apart in November.

The month’s output fell 0.2% despite the expectation of a rise of 1%. This reinforces the view that Europe’s largest economy was at a standstill in the fourth quarter 2021. There has been no relief for several months.

“Unfortunately, here is where German industry has stopped for now. Carsten Brzeski from ING said the fourth wave Omicron, and Pandemic Omicron will send industrial activity back into hibernation.

Retail trade surprised everyone in November and was a bright spot that showed consumers were still optimistic heading into Christmas.

Problem is, households are spending more than they used to, despite restrictions. This is driving up consumer prices.

Unexpectedly, inflation hit 5% last Month, an unprecedented high for the 19-country currency block. It was also uncomfortable reading at The European Central Bank (which has repeatedly underestimated the price pressures).

After the economic shock of last year’s pandemic, prices rose significantly as oil and natural gas prices increased.

The upward pressure was exacerbated by supply-chain bottlenecks that limited the availability of consumer goods. Meanwhile, households started to spend their savings on everything from new cars and restaurant meals.

Although most of these inflation drivers will pass soon, some policymakers and others have doubts about the ECB’s positive narrative that prices growth will return to 2% by year’s end.

Their concern stems partly from the fact that inflation excludes volatile food and fuel prices has increased above target. It suggests that those sectors most prone for low inflation during the last decade may be adjusting.

Despite the fact that stimulus was extended just a few short weeks ago, it is not likely the ECB will reconsider its policy stance before March. Omicron clouding the outlook.

The sentiment survey by the Commission showed some encouraging news with entrepreneurs from the euro area lowering their expectation of price increases for the first month in over a year.