Europe on the brink: the states battling to stave off recession

Almost six months after Vladimir Putin ordered Russian troops into Ukraine, the extent of the damage to the European economy is becoming clear. The red lights of recession are flashing.

The eurozone’s big four economies – Germany, France, Italy and Spain – have all had their growth forecasts for 2023 downgraded by the International Monetary Fund, as a combination of the war and higher interest rates put a brake on activity.

In the UK, inflation is above 10% for the first time in 40 years as households struggle with rising energy bills. The Bank of England forecasts inflation will peak above 13% in autumn after a fresh increase in energy costs, while the economy will fall into a lengthy recession.

While Britain is contending with additional pressures from Brexit, the impact of soaring energy prices, supply chain disruption, shortages of workers and drought are also hitting the rest of Europe. Analysts at the Economist Intelligence Unit say the pain could go on for some time, because countries must wean themselves off Russian hydrocarbons, and building up renewables as an alternative will take time.

“In the near term we expect a recession in Europe in the winter of 2022-23 as a result of energy shortages and sustained elevated inflation”, the EIU said. “The winter of 2023-24 will also be challenging, and so we expect high inflation and sluggish growth until at least 2024.”

Here we assess the chances of recession in the EU – and Russia.

Germany

Europe’s largest economy is in the centre of the storm, as the energy crisis, months without rainfall, and a breakdown in global trade batter its manufacturing base. Economic growth slowed to stall speed in the second quarter and is likely to turn negative in the coming months.

“It will need an economic miracle for Germany not to fall into recession in the second half of the year,” said Carsten Brzeski of the Dutch bank ING. “The fact that the entire German economic business model is currently up for renovation will also weigh on growth prospects in the coming years.”

Russia supplied more than half of Germany’s gas in 2020 and about a third of all oil. Since the outbreak of war, the Kremlin has throttled supplies, blaming technical problems for a fall in volume through the key Nord Stream 1 pipeline.

Drought and scorching temperatures have caused a sharp fall in water levels on the Rhine, a key transport route for Germany’s dominant industrial sector. Water levels have fallen below the critical 40cm mark, preventing barges from being loaded to full capacity. Some routes have been cancelled, causing delays for chemicals firms and other manufacturers in industrial heartlands. Factories along the shores of the Rhine dependent on water for cooling have also faced problems, while coal shipments to power plants – which had been earmarked for keeping the lights on – are likely to be disrupted.

In response to the energy crisis, Berlin will impose a gas levy for households, due to come into effect from October and lasting until April 2024, which is designed to spread the higher wholesale cost between households and industry.

The government has put in place an energy support package worth more than €30bn (£26bn), including a €300 lump sum for workers, extra support for those on welfare, cuts to petrol and diesel taxes and discounted €9 bus and train tickets.

The German chancellor, Olaf Scholz, has also promised a fresh package of financial support.

Chances of recession (out of five)

France

France should be better insulated than many other European nations, thanks to its large nuclear energy sector, which accounts for just over 70% of its electricity generation, but it has been struggling with serious faults at ageing reactors. Although in a less parlous position than Germany, the eurozone’s second-biggest economy could still face damaging power cuts this winter.

GDP rose in France by 0.5% in the second quarter, lower than in other nations across the continent, with domestic consumption notably weak. The government has put in place an emergency support package worth €20bn, including tax cuts at petrol pumps, while capping an increase in regulated electricity prices at 4%, a policy helped by state ownership of the energy giant EDF.

Chances of recession

Italy

The Italian economy has performed much more strongly recently than its big eurozone rivals, notching up growth of 1% in the second quarter. But like Germany, Italy is heavily dependent on Russian gas and has the added complication of being thrown into a fresh bout of political uncertainty after the resignation of Mario Draghi as prime minister earlier this summer.

Opinion polls point to a change of direction from Draghi’s technocratic approach following forthcoming elections. A rightwing coalition government that has been campaigning on a strongly nationalistic and protectionist economic platform is expected to win.

Financial markets and the European Central Bank are already alive to the risks of investors demanding a higher interest-rate premium for buying Italian bonds. With Italy firmly in mind, the ECB announced a new financial instrument last month designed to prevent higher interest rates from having a disproportionately adverse impact on more vulnerable member states.

In early August, Italy approved a new aid package worth about €17bn for consumers and businesses, in one of Draghi’s final acts as leader. A tax cut on petrol and diesel, which had been due to expire this month, has also been extended to 20 September.

Since the creation of the single currency almost a quarter of a century ago, Italy has been the weakest performing of the “big four”, with living standards barely higher than at the end of the 1990s. It is benefiting this year from a boost to tourism, which accounted for 13% of its GDP before the pandemic.

Chances of recession

Spain

Like every other country in Europe, Spain is affected by the war in Russia but of the big four it has the best chance of avoiding recession, despite soaring inflation.

There are a number of reasons for this. Its economy went into the crisis in reasonably good shape and – like Italy – has been given an added boost by the surge in tourism after the pandemic. Tourism accounted for 12% of Spain’s GDP before Covid and an even bigger share of employment.

But Spain is much less reliant on Russian energy than Italy, and is already a big importer of liquefied natural gas from around the world. GDP rose by 1.1% in the second quarter and the IMF expects it to be the fastest growing of the big four next year.

The government has put in place €16bn of financial aid and loans to help companies and households with soaring energy costs.

Chances of recession

Russia

Russia has suffered under the west’s sanctions, plunging its economy into a deep recession and forcing the Kremlin to default on its foreign debts for the first time since 1918, though soaring energy prices have helped blunt some of the impact.

Researchers from Yale University said last month that the west was crippling the Russian economy, although other experts disagree. Holger Schmieding, chief economist at Berenberg bank, said that recent data did not point to such a “stark conclusion”.

Russia’s current account balance – measuring trade and investment flows – more than tripled to hit a record $167bn surplus in the second quarter, helped by high wholesale oil and gas prices swelling exports, while western sanctions led to a fall in imports. The proceeds have been a vital source of hard currency for Moscow, reflected in the rouble erasing losses seen since the start of the invasion.

However, over the long run experts say Russia’s economy will struggle with the loss of western technology and investment. “Our best guess is that Russia is in a major but still far from catastrophic recession”, Schmieding added.