EU.REVIEW

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by Keith Zahra

Unity, resilience spares Europe recession, so far

Uncertainty remains very much the keyword in attempting any economic analysis and forecast for Europe and beyond. Although the situation remains a very volatile one, and the tense geopolitical situation persists, it is safe to say that things could have been worse.

As 2022 approached its latter months, the world’s major institutions and top economists had resigned themselves that recession was an inevitability – it was a matter of when not if. However, as things stand, Europe seems to have averted this predicament, thanks to a mixture of fortuitous turnouts, including favourable climatic conditions, as well as sound and courageous policy decisions.

Despite the surge in energy prices and ensuing record-high inflation, the slowdown in the third quarter turned out milder than previously estimated, and in the fourth quarter, the EU economy managed a broad stagnation instead of the 0.5% contraction expected in autumn. Most importantly, the European gas benchmark price has fallen below its pre-war level, helped by a sharp fall in gas consumption and continued diversification of supply sources. The resilience of households and corporations has been significant and persistent.

The EU has demonstrated agility and a historical sense of togetherness in its efforts to reduce dependency on Russian energy commodities and strengthen resilience against adverse shocks. Halfway last year, the European Council agreed on a ban on almost 90% of all Russian oil imports by the end of 2022, with a temporary exception for crude oil delivered by pipeline.

Taking account of the EU member states’ different energy mixes, conditions and circumstances, EU leaders managed to reach an agreement on diversifying energy supply sources and routes, accelerating the deployment of renewables, improving energy efficiency and improving interconnections of gas and electricity networks. In Summer, after protracted discussions, EU leaders adopted the regulation on reducing gas demand by 15%. Last month, the EU formally adopted an extension of the voluntary gas demand reduction target for one year until 31 March 2024.

A milder than usual Winter, demand restraint and efficiency gains resulted in gas consumption being a quarter below the average price for the same months over the past five years. Stepped-up efforts to diversify supply sources have also yielded important results, as evident from a sharp fall in the share of pipeline gas from Russia in total EU imports of gas and the strong increase in imports of seaborne LNG. Last Summer, Europe was terrified by the idea of not having the necessary gas supplies to take it through the cold Winter, but the above developments meant that gas storage levels did not drop below 75% of capacity at any one point, only marginally below their level at the beginning of the heating season, and above the seasonal average. This has placed on EU countries less pressure on refilling and eased institutional concern about gas rationing going forward.

The earlier-than-expected lifting of coronavirus restrictions, including extensive lockdowns in China is also expected to have a positive impact on global activity, reducing supply chain pressures and giving a boost to international tourism. The latest data indicates a recovery of 75% of 2019 travel volumes to Europe in 2022. This strong tourism rebound is expected to continue well into 2023, though at a slower pace. America leads the recovery of long-haul travel to Europe, thanks to short-lived and fewer travel restrictions and the strength of the dollar against the Euro. According to the European Travel Commission, based on year-to-date data, almost one in four of reporting destinations saw US arrivals exceed 2019 levels.

At the same time, businesses remained resilient, seeking new avenues for growth as consumers resumed spending after the pandemic woes. As a result, employment remained strong, helping households push through the international crisis.

Despite the war, unemployment rate in the EU remaining at its all-time low of 6.1% in December. The Employment Expectations Indicator rose to its highest level since June 2022 in January 2023, although survey findings only suggested a little improvement in labour market shortages. While the temporary slowdown in activity is expected to have an impact on employment, the difficulty in filling positions is expected to remain. As a result, the Centre for Economic Policy Research expects that the little increase in unemployment anticipated for early 2023 would primarily be a passing phenomenon.

Economies resist, but for how long?

Looking forward, as things stand, with a realisation that the war in Ukraine will prolong well beyond Spring, and with the ECB expected to increase interest rates further, the Commission forecasts that GDP will expand by 0.8% in 2023 and 1.6% in 2024 (0.9% and 1.5% in the euro area). Growth inducing factors, including EU funding under the Recovery and Resilience Facility, are expected to help the European economy in these circumstances.

Headline inflation is forecast to fall from 9.2% in 2022 to 6.4% in 2023 and 2.8% in 2024 in the EU. In the euro area, it is projected to decelerate from 8.4% in 2022 to 5.6% in 2023 and to 2.5% in 2024.

Although there is still a lot of uncertainty around the prediction, growth risks are generally seen to be balanced. If decreases in wholesale gas prices translate more firmly into lower consumer costs, domestic demand may increase. Yet, given the global concerns, a potential reversal of that decline cannot be completely ruled out. China’s reopening may strengthen the drive for external demand.

From a policy perspective, It was reassuring to see how well-coordinated the European response to the Russian invasion was, as well as how willing the EU nations were to modify their previous attitude toward Moscow.

Yet, the true test of Europe’s cohesion is yet to come. It remains to be seen how far electorates would back their leaders when their quality of life truly suffers. Originally, the widespread indignation across Europe made it simpler to preserve unity. But given that Russia is applying more pressure and the possibility that the battle might end in a protracted stalemate, the harshest battle for the European economy might still be on the horizon.