High prices choke European economy amid stagflation fears

The year 2022 should, in theory, be the year in which the European Union (EU) definitely overcome the economic problems created by the Covid-19 pandemic, to enter a new chapter of recovery and prosperity.

In practice, it was not quite like that, because Russian President Vladimir Putin decided to invade Ukraine, throwing all predictions and expectations out of the window.

A month after the start of the war in eastern Europe, annual inflation in the euro zone soared to 7.5% from 5.9% in February, defying the consensus of most analysts.

Energy prices recorded an annual increase of 44.7%. An impressive increase compared to the 4.3% rate recorded in March 2021.

Companies across the European continent are now grappling with high, hard-to-pay bills that threaten to cripple production and cause factory closures, as households see purchasing power plummet at record speed.

As Russia shows no signs of wanting to give up the military campaign, uncertainty about the immediate future of the European Union is growing worse with each passing day. The perfect storm of rising prices, strained supply chains and an economic slowdown is fueling fears of stagnation and a sudden halt to the post-coronavirus renaissance.

“Europe is entering a difficult phase. We will face, in the short term, higher inflation and slower growth. There is considerable uncertainty about how big these effects will be and how long they will last”, underlined Christine Lagarde, president of the Bank Central European Union during a speech last week in Cyprus.

“The longer the war lasts, the greater the costs.”

The extreme circumstances put European Union institutions and national governments under enormous pressure to come up with quick and tangible solutions for workers and businesses, before the scars become lasting.

Spain, for example, recently approved an emergency package aimed at mitigating the economic and social consequences of the war in Ukraine, which is taking place at a distance. The plan will mobilize €16 billion in public funds, including €6 billion in direct support and tax cuts.

The country has been one of the hardest hit by the energy crisis that has lasted for months, with inflation reaching 9.8% in March. The worsening situation led the transport sector to call a 20-day strike that left many supermarkets without food and several factories with difficulties to supply themselves.

But even as politicians are racing against time to come up with relief measures, the dramatic evolution of the war is fueling calls for tougher sanctions against Moscow.

New reports of indiscriminate killings in Bucha, a northwest suburb of Kiev, have once again brought up the idea of ​​an embargo on Russian energy imports, a drastic proposal that would plunge the bloc into even greater economic chaos.

Germany, a country heavily dependent on Russian energy, is among the EU member states most reluctant to take such a radical step, fearing the shock will be too strong for its industry.

“German industry sees the risk that companies face existential difficulties because of energy prices or because of the Russian interruption in energy raw material exports,” recalled Joachim Lang, director general of BDI, the federation of German industries, through a statement sent to Euronews.

“Some energy-intensive companies are already being forced to reduce production because of the exorbitant costs of gas and electricity bills.”

The country, an economic power in Europe, now faces a “substantial” risk of recession, warned the council of economic advisers to the German government. The group lowered its 2022 growth forecast from 4.6% to 1.8%, noting that pre-pandemic levels will not be reached until the third quarter of the year.

In Lithuania, the EU country with the highest inflation rate (15.5% in March), companies are struggling to avoid a loss of competitiveness as raw materials from Ukraine, Russia and Belarus are disappearing and alternatives from other stops bring additional costs.

“The Russian invasion of Ukraine will add more fuel to the already ignited fire of inflation, and that fire could burn all Lithuania’s economic growth in 2022,” Vidmantas Janulevičius, president of the Confederation of Lithuanian Industrialists (LPK), told Euronews.

“Rising energy prices have had a major impact on the industry. In addition to the upward trend in commodity prices, the impact of resource growth on companies is becoming difficult to offset.”

The long shadow of stagflation

The turn of events over the past month has inevitably awakened the dreaded specter of stagflation, a period characterized by economic stagnation, inflation and rising unemployment.

The term stagflation emerged during the 1970s when oil producing countries proclaimed an oil embargo after the Yom Kippur war and caused an extraordinary increase in production costs. The crisis led to an “oil shock”, which combined rising inflation with economic decline. The scenario was seen with strangeness: when the economy slows down, unemployment rises and consumer demand tends to fall, pushing prices down.

Fifty years later, a new energy crisis threatens to revive stagflation, if only temporarily.

“This is a nightmare because there is negative growth, but at the same time high inflation. So, interest rates should be raised to combat high inflation, but monetary policy should be kept very loose because the economy is fine,” Peter Vanden Houte, chief economist at ING Belgium, told Euronews.

“For now, energy prices will remain quite high, given the uncertainty of supply from Russia. There is a kind of ‘war prize’ in both the price of natural gas and the price of oil, which will be part of the price while this war last. And we have no idea how long that will last.”

The European Central Bank (ECB) is expected to end the pandemic-era quantitative easing program in the summer and approve a first interest rate hike in the fourth quarter of this year, although the latest economic data may speed up the schedule.

“The data received does not point to a material risk of stagflation,” ECB President Christine Lagarde said in comments ahead of the March inflation figures.

“Growth in the euro zone could be as low as 2.3% in a severe war scenario in 2022,” he added. The estimate was almost half the 4% growth rate that the European Commission had published in early February.

To make matters worse for consumers, inflation must be driven by an impending global food crisis. Ukraine and Russia are considered the breadbaskets of the world, producing around 30% of food commodities such as wheat and corn.

Last week, David Beasley, head of the United Nations World Food Programme, told the UN Security Council that the conflict in Ukraine will create “a catastrophe on top of a catastrophe” and could trigger the worst global food crisis since World War II. World War.

In Brussels, European Union authorities tried to reassure citizens that food supplies are guaranteed, but that medium-term responses are needed to avoid shortages.

March inflation data showed a 5% annual increase in food, alcohol and tobacco, up from 4.2% in February. Unprocessed foods soared 7.8%, driven by seasonal factors, higher transport costs and fertilizers.

The food crisis, the energy crisis, the problems in supply chains and all the other possible ramifications of the war in Ukraine suggest a long and arduous path for the European economy, where high inflation is no longer just a temporary headache. – as many predicted before the invasion – becoming, instead, a long-term challenge.

“We also have to take into account that we will have some second-round effects now that energy and food prices are high. At the end of the day, this could also be reflected in other prices. High energy prices will also make other goods and more expensive services”, warns Vanden Houte.

“In short, let’s say that the decline in inflation will be a very slow process. We will probably have to wait until the second half of 2023 before we can talk about more normal inflation rates again”, adds the chief economist at ING Belgium.

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