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Analysis: As Ukraine war drags on, Europe’s economy succumbs to crisis

It was to be Europe’s star year.

Post-pandemic spending euphoria was supported by large government spending. It was designed to stimulate the economy and give exhausted households a sense of normalcy after two years of terrible events.

All that changed with Russia’s invasion in Ukraine on February 24, 2018. The crisis is permanent and normality has been lost.

Now, a recession is almost certain, inflation is close to double digits, and winter with energy shortages is rapidly approaching.


Even though the outlook looks grim, it is likely that things will get worse before there are any significant improvements well into 2023.

Alexandre Bompard is the Chief Executive at retailer Carrefour ( CARR.PA).. He stated that the “what we’ve been used to over the past decades – low inflation and international trade – it was over”

This is a dramatic shift. One year ago, most economists predicted that 2022 would see an economic growth rate of 5%. A winter recession is now the norm.


In historical terms, the recent rise in inflation in the eurozone has been dramatic.

Both households and businesses are suffering from the effects of war, which includes high food and energy costs. This is being exacerbated now by a severe drought and low river levels, which restrict transport.

Inflation in the eurozone stands at 9%. It is draining purchasing power and causing a shortage of cash to buy petrol, natural gas, and staple foods.

Retail sales have already fallen months before heating season begins, and customers are reducing their purchases. Retail sales volume fell nearly 4% in June compared to a year ago, mainly due to a 9% decline in Germany.

Discount chains are popular with consumers who will give up expensive products to shop at discount stores. They are also starting to skimp on certain purchases.

Robert Gentz, co-CEO at Zalando in Germany, stated to reporters that “life is becoming more costly and consumers are reluctant”

Despite persistent supply constraints, businesses have fared well due to their excellent pricing power. However, energy-intensive sectors are already in trouble.

Nearly half of Europe’s zinc and aluminium smelting capacities are offline, while much of Europe’s fertilizer production, which depends on natural gas has been stopped.

Tourist has been a rare bright spot for people who want to save some money and have a carefree summer.

However, even the travel industry is affected by a lack of capacity and labour shortages. This is because workers who were laid off during the pandemic are reluctant to return.

Frankfurt and London Heathrow, two of the most important airports in Europe, had to limit flights because they didn’t have enough staff to handle passengers. In summer 2018, waiting times at Schiphol in Amsterdam could reach four to five hours.

The airlines also struggled to cope. Lufthansa in Germany ( LHAG.DE ) had a public apology to its customers for the chaos and said that it was unlikely that it would improve anytime soon.

This pain will likely intensify, particularly if Russia reduces gas exports.

Capital Economics’ Caroline Bain stated that the gas shock is now much more severe than it was in the 1970s when oil prices were high. “Over the past two years, we’ve seen a 10-11 fold increase in spot prices for natural gas in Europe.”

The EU has announced plans to accelerate its transition from Russian gas to renewable energy. However, it is facing a shortage of gas, which will force it to cut 15% this year.

However, energy independence comes with a price.

It will lead to colder homes and offices for ordinary people in the short term. Germany, for example, wants public spaces to be heated to 19 degrees Celsius in winter, compared to 22 degrees earlier.

It will also lead to higher energy prices and inflation, as the bloc must abandon its largest and cheapest energy sources.

It will result in lower production for businesses which can impact further growth, especially in the industrial sector.

The bloc’s largest economy, Germany, has seen its wholesale gas prices rise fivefold in one year. However, long-term contracts protect consumers so the impact on the market so far has been much smaller.

They will still have to pay a mandated levy by the government and prices will rise once contracts are extended. This suggests that inflation will not be a problem as long as there is a delay.

Many economists believe that Germany and Italy will soon be in recession, as they are Europe’s top two and fourth largest economies, respectively.

Although a recession is possible in the United States, it will likely be caused by something very different.

The US Federal Reserve is struggling with a hot labour market and rapid wage rise. It has raised interest rates quickly and made it clear that it is willing even to risk a recession in order to control price growth.

The European Central Bank, however, has only raised rates once and returned to zero. It will continue to move cautiously because increasing the borrowing costs of euro zone countries such as Greece, Spain, and Italy could increase their vulnerability to default.

However, Europe will find its strengths in a recession.

Record levels of employment are being achieved, and many firms have suffered from growing labour shortages for years.

This means that companies will want to retain workers, especially as they face a downturn with healthy margins.

This could sustain purchasing power, pointing towards a relatively mild recession with only a slight uptick in the record-low jobless rate.

Isabel Schnabel, an ECB board member, stated that “we see continuing acute shortages in labour, historically low unemployment, and a large number of vacancies.” “This suggests that, even in a downturn we may see firms reluctant to lay off workers on a large scale.”

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