Economists warn that a recession late this year or early next year looks increasingly possible as risks mount.
“We’re not in good shape,” said Erik Nielsen, group chief economics advisor at Italian bank UniCredit. “I think there’s a good chance we’re going to have a recession in Europe over the winter.”
The biggest concern for Europe’s economy is access to energy. Fears have mounted that Moscow could cut off gas supplies to retaliate for tough sanctions after invading Ukraine, sending the bloc a massive shock as the Czech Republic and Hungary could slide into a deep recession and face a GDP slump of up accept 6%. Germany’s leading forecasters have predicted that Europe’s largest economy will lose 220 billion euros ($225 billion) over the next two years. Already 12 EU member states have had their gas supplies cut off in whole or in part from Russia, according to the European Commission, which unveiled its contingency plan to conserve gas for next winter on Wednesday. The flow of Russian gas to Europe is less than a third of what it was this time last year, the commission said.
A pivotal moment in the stalemate is looming. Concerns have risen since Russian gas giant Gazprom shut down the Nord Stream 1 pipeline for scheduled maintenance 10 days ago, pushing European gas prices to their highest levels since March. Flows through the pipeline are essential and have historically supplied an estimated 12% of EU demand, according to S&P Global Platts.
Gazprom is scheduled to resume operations on Thursday. However, officials have expressed doubts as to whether the pipeline will even come back to service – and if so, how much gas will be transported through it.
“It is impossible for us to predict how Gazprom will behave,” an EU spokesman told CNN on Tuesday.
The volumes from Nord Stream 1 to Germany had already fallen sharply before the start of the maintenance work. They collapsed 60% last month, forcing Berlin to declare a “gas crisis.”
On Tuesday, Russian President Vladimir Putin said Gazprom would “fulfill all of its commitments,” despite warning that a dispute over vital turbines, which was embroiled in sanctions, was jeopardizing supplies.
Even if flows resume without incident, the specter of future choking will hover over Europe, holding back investment and confidence.
“What we’re going to get is an extended period of uncertainty, which isn’t going to bode well for the business cycle,” said Guillaume Menuet, Citi Private Bank’s head of investment strategy and economics in Europe, the Middle East and Africa.
inflation
Annual inflation in the European Union rose to 9.6% in June. It reached 8.6% for the 19 countries using the euro.
In order to limit price increases, the European Central Bank will raise interest rates on Thursday for the first time since 2011. But there is a tough fight ahead to get the situation under control.
The central bank is lagging behind rivals like the Federal Reserve, which started raising interest rates months ago. Interest rates in Europe have been negative since 2014, meaning it is further behind. And if an energy shortage plunges the region into recession, the central bank could be forced to abruptly halt interest rate hikes, hurting its ability to continue fighting inflation.
“Everything that’s happening right now limits the room for the ECB to go really big,” said Carsten Brzeski, global head of macro at ING, a Dutch bank.
Should a recession hit, inflation could subside without the central bank having to intervene much more. But economists are hardly in favor of that outcome, which would also usher in a wave of job losses.
climate change
Wildfires sweeping across Spain and France as a heatwave sweeps the region could also dampen economic activity.
Almost half of Europe’s territory, including the UK, is “at risk” from drought, EU Commission researchers said on Monday.
Germany, meanwhile, is struggling with a drop in water levels along the Rhine, an important trade artery. There are already signs that shipping will be affected.
“Low water levels mean that barges have to sail with reduced cargo to limit their draft, or even stop operations altogether,” Berenberg Bank said in a research note published on Wednesday. “As a result, volumes shipped are falling and freight rates are rising.”
That could weigh on Germany’s hugely important manufacturing sector. Researchers at the Kiel Institute for the World Economy found that in a month with 30 days of low water, the country’s industrial production fell by around 1 percent.
Political rumors
Meanwhile, high-stakes political drama is unfolding in Italy, the European Union’s third-largest economy.
Prime Minister Mario Draghi is trying to stay in power after his governing coalition collapsed last week. He urged lawmakers on Wednesday to back the national unity government to avoid snap elections.
Draghi, who used to run the ECB and is popular among investors, tried to resign after the 5 Star Movement – the largest party in the country’s coalition government – withdrew its support, claiming Draghi’s package to combat the rising cost of living not done it. don’t go far enough.
Should Italian leaders be forced to call snap elections, investors fear the country’s right could step up its support, raising questions about European cohesion at a weak time.
“If you look ahead now – especially for growth and for the economy – political developments are clearly a risk,” Brzeski said. This should be a year of relative political stability after France’s spring elections, he added.
Investors have dumped Italian bonds while monitoring the situation, which has pushed yields higher. This further increases the stakes for the ECB, which is expected to unveil a new tool on Thursday that would counter dangerous bond market fragmentation. If bond yields in Italy or other highly indebted countries like Greece shoot up too high, there are fears that financial conditions will deteriorate rapidly.
risk of recession
An economic forecast released last week by the European Commission forecast that the EU economy will grow by 2.7% in 2022 and 1.5% in 2023. Annual average inflation is expected to hit a record high of 8.3% this year before falling to 4.6%.
According to Sylvain Broyer, chief economist for Europe, Middle East and Africa at S&P Global Ratings, a recession is not a given. Household finances remain strong and public investment is increasing, he noted in a recent research note.
This summer is also expected to bring a busy travel season despite the chaos at airports, supporting economic activity.
Broyer said that while “a sharp slowdown in growth is 100% certain,” the odds of a “full-blown recession” are slimmer — somewhere between 30% and 43%, according to his estimate.
Nevertheless, the chances increase. A Bank of America survey of European fund managers released this week found that 86% of respondents expect a recession next year, up from 54% in June.
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