How steep will the upcoming Euro Area downturn be?

In our latest insight piece, we look at the likely severity of the Euro Area’s coming economic downturn.

Hit by high inflation and tighter monetary policy, there is no doubt that the Euro Area’s economy will slow in the coming quarters; the real question is by how much. According to the latest forecasts from our analysts, the Euro Area as a whole will contract in Q4 2022 and Q1 2023, before returning to growth from Q2 2023 onwards. That said, the decline is projected to be far milder than during the Covid-19 lockdowns of early 2020, or the Global Financial Crisis of 2008/09.

There are forecast to be significant divergences within the bloc. Looking at major economies, Germany and Italy are will likely see the largest downturns. In contrast, France will be less affected, thanks to its strong domestic nuclear power generation and relatively limited inflation. Spain will also see only a mild downturn, due partly to its reliance on gas from Algeria rather than Russia.

The fiscal support measures announced to date at both a national and EU level—and further measures which are likely ahead—will cushion the coming slowdown. Gas availability over the winter will also be a key factor to watch. On this front, recent trends bode well for the avoidance of enforced gas cuts to industry: Weather is currently warmer than normal and should remain mild in the coming weeks, limiting gas heating demand. Gas prices have tumbled in recent months. And European gas storage facilities are virtually full thanks to strong LNG imports. However, a prolonged cold snap this winter, sabotage at energy facilities and an eventual cutoff of Russian gas supply via Ukraine could yet cause the panorama to deteriorate.

Insights from Our Analyst Network

Regarding gas supply, Berenberg’s Salomon Fiedler said:

“The EU now has likely stored enough natural gas to get through the coming winter without having to curtail gas deliveries to industry by decree. If gas imports from non-Russian sources stay at their recent elevated levels and companies and households continue to respond to high prices by consuming less, the EU will likely be able to avoid outright shortages and rationing both this winter and next – even if all imports from Russia were to cease from November onwards.”

On the longer-term picture, ING's Carsten Brzeski said:

“While everyone is still assessing the depth of a potential winter recession, another risk has not yet received sufficient attention; the eurozone may be witnessing the end of the business cycle as we knew it. Energy prices are very likely to remain high – very high – in the coming years. This will be a structural, not just cyclical burden on companies’ cost competitiveness and households’ purchasing power. It is a structural shift that could be compared with the deleveraging many eurozone countries saw after the financial crisis and which led to subdued growth for many years. Consequently, the risk is high that the eurozone economy will not experience a V-shaped or U-shaped recovery but rather, a J-shaped recovery.”

 

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Author: Oliver Reynolds, Economist

Date: October 28, 2022