Moody’s Analytics: Inflation, ECB, energy and pandemic lead to eurozone recession

Her Eleftherias Kourtali

The eurozone was still fighting the threat from COVID-19 when Russia invaded Ukraine. While the risk of a pandemic has eased, at least for now, the two together create a very bleak outlook for the eurozone, according to Moody’s Analytics.

In the basic scenario of the house, the eurozone will be able to escape the recession, although it is possible to experience quite difficult quarters, but the possibility of recession has increased significantly in recent months. “We now have a 50% chance that the eurozone will enter a recession in the next 12 months. There are no major imbalances, such as bubbles in the housing market and the financial sector, which suggests that the eurozone may not be hit hard by the activity and “However, the recession could last for several quarters,” he said.

Growth in Europe has slowed significantly in recent months. The narrative at the beginning of the year focused on the fact that Omicron is a temporary “weight” in growth with the expectation that it would then give way to a favorable period of activity in the spring and summer. Energy prices were expected to fall and supply chains to normalize, allowing prices to ease, giving the European Central Bank plenty of time to prepare for a gradual rise in interest rates.

The Russian invasion of Ukraine on February 24 overturned this narrative and led to the emergence of very important geopolitical concerns that significantly affected the economic outlook.

Four months after the invasion, with no signs of Russia withdrawing from Ukraine and with international sanctions putting pressure on the Russian economy, the outlook for the European economy is arguably bleak, according to Moody’s Analytics. The hope that the summer will allow European consumers to get back on their feet has given way to concerns about the pressure of high energy and food prices. There is also a strong possibility that Europe may not actually have enough gas to power its industry and heat its buildings in the coming months, and the speed with which the ECB is trying to normalize monetary policy raises the question: Is Europe on the brink of the next recession? Four factors indicate that the risk is high: rising inflation, monetary policy, the energy landscape and the never-ending pandemic.

Inflation

Inflation in the euro area is at 8.1% and is expected to increase further. Historically, inflation in 2001-2020 averaged 1.7%, which means that inflation is currently 6.4% above average. This period is also the most extreme in the history of monetary union, as noted by Moody’s Analytics. Analyzing inflation in subcategories, the rise of the energy component was remarkable and represents almost half of the total. The rise in energy prices that began last year not only continued in 2022, but was exacerbated by the Russian invasion of Ukraine, the subsequent embargo and oil sanctions imposed by various countries, and gas security issues in Europe.

Food prices have also risen in recent months, according to the house. Given the current prices of agricultural products and the production cycle, this component of inflation is likely to contribute to a further rise in inflation, while prices of other goods and services are also rising. The current geopolitical situation poses significant further upside risks to inflation, especially from higher energy prices. A further shock to energy prices could be enough to lead the eurozone into recession.

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Persistent inflationary pressures and the actions of other central banks such as the Fed and the Bank of England, both of which are ahead in terms of tightening, have led the ECB to abandon its gradual approach to monetary tightening. Expectations before the Russian invasion of Ukraine were for gradual interest rate hikes by the ECB, starting in late 2023 or possibly even 2024. Now the rise in interest rates in the eurozone in July is certain, while the possibility of interest rates of up to 75 basis points in a single meeting later this year show how much the ECB’s stance has changed.
The ECB faces a difficult challenge, Moody’s points out. Having left the problem of inflation for so long, he now has to run to close the gap with other central banks in the fight for control. Unfortunately, at the same time, it is in danger of leading the eurozone into recession.

Energy security

The eurozone’s historical dependence on Russian energy imports is proving to be a major vulnerability. Of particular concern is the possibility of a complete cessation of gas supplies from Russia. Russian gas supplies to Europe have fallen in the last 12 months and Europe has had to turn more and more to imported LNG to offset that loss. Its latest plan for 2022 aims to reduce its dependence on Russian gas by two-thirds this year, leaving Russian gas accounting for about 10% of EU annual consumption.

The EU plan is ambitious, the house says, but it does not protect Europe from supply disruptions. With gas flowing through the Nord Stream pipeline in Germany at about 40% of capacity, attention has turned to the eurozone’s ability to withstand a complete shutdown of gas supplies from Russia. Summer may seem easier to deal with than winter, as gas demand is seasonal. However, the outage even for the next two months could lead to the imposition of an energy card, warns Moody’s.

The EU has set a target of 90% storage fullness by 1 November, the date corresponding to the normal annual peak of gas storage. With stocks operating at 55% capacity, there is great concern that the target is difficult even without supply disruption in the coming months. Supply chain pressures will be felt globally and the impact could lead the German and other eurozone economies into recession.

Pandemic – Possible new lockdown in winter

Last but not least, COVID-19 is still with us, as Moody’s notes. Restrictions have been lifted in the eurozone, cases have dropped and mobility has increased in recent months. Europeans have started to travel more, move around and have started returning to work. While this reduction in cases and recovery in mobility is encouraging, cases have begun and are rising sharply in all European countries.

Although the economic impact is diminishing with each successive wave of the pandemic, there is a possibility that in the coming months a more deadly mutation in the virus could coincide with a weakening of the immune system and require greater rigor to combat it. The summer holidays are just around the corner and eurozone countries are unlikely to be locked in during this time of year, but the outlook for next winter looks more uncertain. Increasing cases in the winter months will hit growth, while a more dangerous mutation will increase the chance of recession.