Goldman Sachs: The possibility of a recession in the eurozone increases to 50%, a new rally is coming in natural gas prices

Her Eleftherias Kourtalis

To 50%, Goldman Sachs increases the chances of a recession in the eurozone and proceeds to downgrade its forecasts for the path of the region’s economy this year – considering that the technical recession is already very close – but also for 2023, while inflation will continue to “beat” records. This is based on the fact that it estimates that natural gas flows through Nord Stream 1 will not be fully restored after the completion of the maintenance works, while their interruption is very likely with the natural gas price (TTF) in this case soaring even at 237 euros.

As it pointed out in a report today, natural gas flows from Russia to Germany via the Nord Stream 1 (NS1) pipeline are now only at 40% of capacity, a sharp decline from early June and below its previous expectations Goldman Sachs for 65%. While the American bank has a more pessimistic view than the market estimates (consensus) for the growth of the eurozone since the beginning of the war – mainly due to the expectation of some disruptions of natural gas supplies – the further decline of natural gas flows in the last weeks suggests additional downside for European growth and an upward trend for inflation.

In its basic scenario, the American bank now expects gas flows through NS1 to remain contained at 40% of capacity even after maintenance works are completed in July (vs. a partial normalization previously expected). Therefore, he estimates that gas prices in Europe will move much higher going forward and a further fall in industrial demand for natural gas is expected. Specifically, he estimates that prices (TTF) will reach up to 237 euros/MWh as the storage must be replenished next year in case of a complete interruption of flows, while if flows move to 40% then prices will be well above 150 euros/MWh.

Accordingly, Goldman Sachs further downgrades its growth forecasts in the coming quarters, forecasting growth of just 0.1% (vs. 0.2% previously) and 0.0% (vs. 0.3% previously), in the third and fourth quarters respectively. This cuts its forecast for growth across the region significantly below consensus expectations (which remain at 0.5% for both the third and fourth quarters) and lowers its forecast for 2023 to 1 .1%, against market expectations for 1.9% growth.

“So we see the Eurozone on the brink of recession in the second half and we expect a technical recession in Germany and Italy”, as he notes.

Given these downgrades on growth path, Goldman raises the short-term probability of a recession in the euro area to 50% (from 40% previously).

It also upgrades them its inflation forecasts in the euro area and sees peak at 10.3% y-o-y in September; while on average he estimates that it will be 8.4% in 2022 and 5.1% in 2023.

While the normalization of natural gas flows would imply higher growth and lower inflation than Goldman’s new baseline forecasts, risks remain. In particular, it estimates that the eurozone will be pushed into a clear recession if natural gas flows through NS1 stop completely, with real GDP falling by 1.2%–2.7% by the first quarter of 2023, depending on the negative effects on consumer confidence. The US bank’s analysis shows that the contraction in such a scenario would be particularly large in Germany (1.7%-3.2%) and Italy (2.6%-4.1%) given their heavy reliance on Russian gas. While the end of Russian gas flows would push inflation even higher, the extent of the increase is uncertain given a range of possible outcomes regarding the pass-through of natural gas prices to retail prices.

From a fiscal policy perspective, Goldman Sachs expects further fiscal measures to limit the negative impact on disposable income and to support businesses. Particularly, it expects about ¼ of any further shocks to real GDP to be offset by governments. With the exception of France and Spain, where price caps cloud incentives for lower consumption, further support is expected in the form of income support payments to households to partially shield household consumption but also to continue providing incentives to reduce energy consumption.

As for her ECB, is expected to outpace the fact that natural gas disruptions are weighing on growth but also raising inflation in the second half, and will proceed to increase interest rates by 25 bp in July and 50 bp in September and October, and 25 m.v. in December. Beyond the short term however, rate rises in the event of a complete shutdown of NS1 flows will continue but at a slower pace.