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How did the war affect the European economy

Aafter three o’clock After years of pandemic shutdowns, renewed prosperity, wars, clogged supply chains and emerging inflation, European policymakers see 2023 as the year the old continent returns to a new normal of decent growth and sub-2% inflation. The European economy is indeed stabilizing. But unfortunately, the new normal is much worse than economists expected.

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Start with the positive. The eurozone has proved to be remarkably resilient given the shock of Russia’s invasion of Ukraine and the energy crisis. Natural gas is now cheaper than it was on the eve of the conflict after prices soared last summer. The government has not been forced to ration energy as initially feared, partly because of the unusually warm weather. Headline inflation, which hit a record 10.6 percent in October, is declining.

Nor is industry collapsing because of fuel costs, as the doomsayers predicted. In Germany, output at energy-intensive factories has fallen by a fifth since the war began as imports replaced domestic production. But overall production was down just 3% by the end of the year, in line with pre-pandemic trends.Newest ifo Survey shows manufacturers are as optimistic as before covid-19.

While the German economy shrank slightly in the fourth quarter of 2022, the euro zone defied recession expectations. The EU will also avoid contraction this quarter, according to the latest forecasts from the European Commission. Recent sentiment surveys support this prediction. The widely followed Purchasing Managers Index (production index) has risen in recent months, suggesting a more optimistic picture is emerging for manufacturing, especially services.

Economic stability keeps people employed. In the fourth quarter of 2022, employment rose again across the euro area. Unemployment is at its lowest level since the creation of the euro in 1999; in surveys, companies express interest in new hires. Work keeps people consuming. Despite high energy prices, consumption contributed 0.5 percentage points to quarterly growth in the second and third quarters of 2022. In many countries, “energy shocks take time to affect consumers because high prices are only transmitted with a lag,” said Jens Eisenschmidt of Morgan Stanley Bank. “At the same time, government fiscal help has helped household spending.”

The question now is how long they will continue to spend. Households start tightening their purse strings in the fourth quarter of 2022.In Austria and Spain, specify gross domestic product Data show that consumption dragged down quarter-on-quarter growth by one percentage point. Compared with the previous month, retail trade in the euro zone fell by 2.7% in December. State subsidies and price caps will be eliminated this year. Consumption could become an issue.

Meanwhile, inflation proved stubborn. “inside European Union We have 27 different ways of passing wholesale energy prices on to consumers, which is a nightmare for forecasting,” lamented a commission official. Some price pressure may still be on the way – as was the case in Germany, which China’s energy prices rose 8.3% in January from December. Even if wholesale prices stabilize at current low levels, household prices may be unstable.

A strong job market in Europe could fuel inflation. High prices and labor shortages, likely to worsen as older people retire and fewer young people enter the labor force, are pushing up demand for wages. In the Netherlands, wages rose by 4.8% year-on-year in January, following growth of only 3.3% in 2022 and 2.1% in 2021. German public sector unions have threatened more strikes. They want raises of up to 10.5%, which could set the tone for comrades elsewhere.

Figures from job site Indeed show that wages in the euro zone tend to track underlying or “core” inflation. This shows no signs of softening. The consumer price index, which excludes food and energy, rose 7% in the year to January.According to the agency, the service sector in particular faces sharply rising costs production index investigation, which could lead to further price increases.

This leaves the ECB with no choice but to keep interest rates high. The market expects them to rise to 3.7% from 2.5% over the summer. As a result, money for businesses and households will become more expensive, hitting investment. Credit standards are already tightening, according to the bank’s lending survey. According to Mr Eisenschmidt, much of the impact of monetary tightening has yet to be felt.

The euro zone may have escaped recession so far, but the outlook – stubborn core inflation, high interest rates and a weak economy – is not a pleasant one.this International Monetary Fund Growth is expected to be 0.7% in 2023; the committee forecasts 0.9%. Even that may be optimistic. The US faces similarly stubborn inflation, while China’s reopening hasn’t given the EU much of a boost. Welcome to the grim new normal.

For more expert analysis of breaking economic, financial and market news, sign up for Money Talks, our subscriber-only weekly newsletter. And read our recent coverage of the Ukraine crisis.

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