High energy prices and a strong USD will push most European regions into a recession. Key concerns are high inflation, falling confidence, increasing cost of credit, and weak external trade damaging growth across the region.
But this is not all. Recently, we came across an interesting analysis, i.e., the breakdown of inflation. The IMF analysis suggests that the pandemic and war at the Eastern front of the EU might have fundamentally changed the inflation composition. Reasons provided for a huge unexplained part of inflation are the catch-up effect, less economic slack than forecasted by the CB, and preventive price increases to compensate for oncoming higher input prices.
Europe’s resources issue
Based on present forecasts, the winter of 2023/24 presents some risks around energy supplies, as Europe will need to replenish its depleted gas storage. A critical measure is a replenishment of 90%. It can be assumed that by autumn 2023, a number of additional terminals for LNG will go online which will help to manage the gas reserve more on a spot basis. Another critical point is the availability of basic resources and semiconductors. The deliveries for 2022 occurred mainly on contracts that were negotiated during 2021 and erly 2022. Elevated inflation and sanctions make the availability of these products a rare article for 2023, therefore more expensive.
In a nutshell, the process of tightening macroeconomic policies is expected to bring inflation under control. The ECB has assured, in these extraordinarily uncertain times, to stand ready to adjust policies in either direction in response to a given scenario. While for now the Central Bank is expected to raise policy rates, real rates, though, will stay much below the long-term trend which over time will pose an issue for a population that is on average a net creditor.
Finally, we note that higher interest rates will dampen investment spending and general consumption. European companies will feel the effects of slower growth in the US and China, where the zero-COVID policy has done substantial economic damage.