Europe's prospects

Europe's prospects

24 August 2022 from Anna Svahn

Promises of eternal growth forecasts have been replaced by headlines describing how an era of low inflation is over for good, how Britain's growth has shrunk the most since 1709 and how the winter will be cold due to the energy crisis. By contrast, Germany may be going to keep shutting down their nuclear reactors.

There is much to say about the logic behind Germany's energy policy but that requires a post of its own. Instead, this article will focus more on the outlook in Europe, and whether the ECB has fallen too far behind to seriously tackle the inflation that prevails in the Eurozone.

But, before the rest of Europe and the European Central Bank (ECB), Citigroup's latest forecast of UK inflation should be mentioned. Indeed, Citi believes that after energy prices have pulled back more than expected, this will lead to inflation in the country reaching over 18% by early 2023 (Schomberg, W. (2022). UK inflation to hit 18% in early 2023, Citi forecasts. Reuters. 22 Aug.). With interest rates currently at 1.75% and an actual inflation rate of over 10%, it will take a lot for the Bank of England (BoE) to seriously tackle the problem, if it is not already too late.

In the rest of Europe, the outlook looks pretty bleak too. Gas prices in Europe rose 20% on the news that Russia has decided to shut down Nord Stream 1 for maintenance from 31 August to 2 September without any prior planning.

Note: Past performance is not a reliable indicator of future performance. MMBtU = million British thermal units, a measurement for Natural Gas.

As can be seen in the chart above, gas prices in Europe have risen sharply in the shadow of the energy crisis we were already facing before Russia's invasion of Ukraine. Since then, things have got much worse and residents across Europe are worried about how they can afford further rises in energy and food costs.

It is clear that the idea of a 2% inflation target world is long gone, and that prices will continue to rise. The fact that price rises are now due more to imbalances in supply and demand than 14 years of loose monetary policy also means that the power of central banks is limited. Certainly, a recession can be expected to eventually depress demand and thus prices, but the idea that it would lead to a deflationary state seems remote. Moreover, extremely high energy prices may instead lead to further, albeit short-term, stimulus if the only way to afford rising electricity prices is financial support.

The outlook in Europe is bleak, and the light in the tunnel is almost non-existent. High inflation is here to stay and sooner or later the ECB will have to normalise interest rates which will be another setback for Europe.

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29/11/2022 05:37:08


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