Cracks in eurozone economy widen as war rages in Ukraine

Sanctions against Russia since its invasion last month have pushed energy prices to record highs on the continent, eroding confidence and raising the risk of another recession, even before some states have recovered from the COVID-driven recession.

Germany, the bloc’s largest economy and one of the most dependent on Russian energy, will be among the hardest hit, and the government’s Council of Economic Advisers cut its growth forecasts for the period by more than half a year to 1.8% on Wednesday.

“The risk of a recession is significant,” said Volker Wieland, one of the council members, adding that it will now take until the third quarter for the economy to recover to its pre-pandemic size.

The advisers, whose forecasts guide the government when setting fiscal policy, also predicted that inflation in Germany would double to over 6%.

As the government initiated a contingency plan for possible gas rationing in the event of a disruption or cessation of supplies from Russia, Mr. Wieland said Germany should work to end dependence on Russian energy, perhaps at a cost longer than expected nuclear power program.

For now, this will push inflation forward, he said, but improve the country’s long-term security and economic stability.

European Central Bank President Christine Lagarde also warned that if the conflict drags on, the European economy could suffer more than feared just a few weeks ago.

“The longer the war goes on, the higher the economic costs will be and the more likely we will be in the worst-case scenario,” she said in her speech.

In Vienna, Austria’s central bank cut its growth forecast and sharply raised its inflation forecast for this year, saying its new forecast would worsen further if the war drags on.

Stagflation dilemma

Ms Lagarde said households are already becoming more pessimistic and companies may soon delay their investments.

His warning was underscored by a sentiment indicator that showed the war had eroded consumer confidence in the eurozone and inflation expectations had shot up.

The European Commission economic sentiment index fell to 108.5 in March from a revised reading of 113.9 in February, while consumer confidence fell to -18.7 from -8.8.

The biggest blow to confidence has been inflation, which is eroding consumer purchasing power, even as governments are quick to introduce subsidies to ease the pain.

In Spain, one of the bloc’s largest economies, inflation accelerated to 9.8% in March, the fastest pace since May 1985, from 7.6% in February.

Germany’s regional inflation data also showed strong gains, suggesting that nationwide data due later Wednesday could top 7%.

Growth stagnation coupled with high inflation – stagflation in economic jargon – leaves Ms Lagarde’s ECB in a dilemma.

While the central bank usually tightens policy to fight inflation, such a move could exacerbate a recession and hurt consumers even more.

To mitigate that risk, Ms Lagarde has vowed to move only in small steps without making any long-term commitments.

“Progressive means that we will proceed cautiously and adjust our policies as we receive feedback on our actions,” she said.

This policy dilemma, in turn, could further split the ECB’s rate-setting Board of Governors, as conservatives are already calling for higher rates to fight high inflation.

“If… the war… does not become a global conflict, then I think the first (rate) hike could happen towards the end of this year,” said ECB policy chief Peter Casimir.

Leave a Comment