The Russian aggression against Ukraine not only brutally violated all international norms, but also triggered far-reaching economic consequences related to the re-orientation of trade and energy policies.
Starting with an economic blackmail in 2021 and causing the current drop in gas supplies in Europe, the war has made 2022 a year of bursting speculative bubbles in global markets. It also set the EU economy on a course towards recession or stagflation. But there may yet be a silver lining to the crisis, just like there was in the 1970s.
Slowdown that may turn into stagflation
.A series of data generated by the surveys measuring the expectations of European industry managers (Purchasing Managers Index – PMI) paint a picture of an economy in recession. All the figures for Germany, France and the entire eurozone are now in red, falling below 50 points, a borderline between economic growth and economic slowdown. PMIs for services in France and the eurozone still manage to stay above that line, but it doesn’t look like they are going to hold out for long.
In its summer economic forecast, the European Commission expects inflation will be at a record high this year across the EU and the eurozone. It has also revised downwards the growth expected for the turn of 2023.
As forecast by the Commission, the EU economy will grow at 2.7% in 2022, and 1.5% in 2023.
The Commission expects that, in 2022, inflation will reach an unprecedented 8.3% across the EU. In 2023, the figure will drop to 4.6%.
The European Central Bank has launched a cycle of interest rate hikes, initiated with an increase by 50 bp. In addition, the official bank rate went up from –0.5 to 0%, putting an end to the 11-year-long streak of negative interest rates. However, in spite of the higher-than-expected increase of the rates, the euro failed to continue its rise against the US dollar. This is because there was no clear signal that further increases would follow in September, as those depend on the data from the August-September period.
According to the forecasts made by most European economists, economic growth will slow down significantly in the second half of 2022, but will then pick up steam in 2023. Faced with high inflation and increasingly difficult financing, it will be important to strike the right balance between pursuing a more prudent course in budgetary policy and protecting those most in need. All this must go hand in hand with reducing dependence on Russian fossil fuels. Given that we don’t know how the war is going to develop and what will happen to gas supplies, this forecast is very much uncertain and fraught with the risk of downturn.
1970s à rebours
.The 1970s are not remembered well in France and across the western countries. It was a time when average Europeans experienced a decline in their quality of life. It was also a time of stagflation. Now, just like then, we are experiencing supply shocks – at the time, the reason was the oil embargo declared by the Arab states; today it is the pandemic and the Russian aggression against Ukraine together with its consequences. As then, inflation is on the rise and economic growth is falling. The 1970s economic crisis was caused by overdependence on crude oil supplies coming from one source and wasteful technologies.
Its immediate effect was the French Messmer’s plan providing for extensive investment in nuclear energy. It was thanks to that plan that France gradually increased its strategic autonomy. The USA did the same. The industry also began producing small-engine vehicles that needed less fuel.
The changes benefited those countries and brands that knew how to ride the wave of the global transformation. Such was the case of Japan’s Toyota and Honda which offered fuel-efficient cars that the U.S. giants struggled to produce, or the Danish companies like Vestas, which began to ramp up the production of wind turbines, and Danfoss, which, at the time, focused on heat pumps.
What lesson can we draw from the crisis of 50 years ago?
.You cannot go too far raising interest rates when price determinants are beyond the control of central banks. There is a fine line between a soft landing and an economic crisis in which unemployment is rising and an entire generation is deprived of opportunities for advancement. Europe has already seen this after 2008.
The on-going Russian energy crisis is also an opportunity to speed up the development of nuclear technology, which may help us phase out fossil fuels. Some states that wanted to turn away from nuclear (e.g. Belgium) have changed their mind about this solution and abandoned their anti-nuclear plans.
The accelerated phase-out of fossil fuels, coupled with increased efficiency and energy independence, could be the key change for which we will be remembered by future generations. Let’s hope we don’t waste that opportunity, because it just might be the way to avoid stagflation.