High prices are suffocating the European economy and heightening fears of stagflation

High prices are suffocating the European economy and heightening fears of stagflation
Written by on100dayloans

2022 was to turn the page on the economic crisis caused by the covid-19 pandemic. The EU was to write a new chapter of recovery and prosperity this year. Corn the invasion of Ukraine by Russia sweeps away all projections.

A month after the start of the war, theinflation year in the euro zone jumped to 7.5 %, compared to 5.9% in February. This trend defies the majority consensus of analysts. Energy prices alone rose 44.7% year-on-year, a staggering increase from the 4.3% recorded in March 2021.

Businesses across the continent are receiving incredibly high bills. This outbreak threatens to disrupt production and lead to closing of factories. For households, the penalty is the same, they see their purchasing power diving at record speed.

With Moscow showing no signs of backing down from its military campaign, uncertainty about the immediate future of the EU is only growing. The superposition of the price increasefrom supply chain disruptions and the economic downturn are fueling fears of stagnation and an abrupt halt to the post-coronavirus recovery.

“Europe is entering a difficult phase. We will face, in the short term, higher inflation and slower growth. There is great uncertainty about the magnitude of these effects and their duration.“, explains Christine Lagarde, President of the European Central Bank (ECB).

The longer the war lasts, the higher the costs are likely to be.

These exceptional circumstances put European institutions and national governments under enormous pressure to provide quick and tangible solutions to workers and businesses before the scars become too deep.

I’Spain recently approved an emergency plan aimed at alleviating the economic and social consequences of the war in Ukraine. The plan will mobilize 16 billion euros of public funds, including 6 billion euros in direct support and tax reductions.

The country is one of the most affected by the electricity shortage which has lasted for months. I’inflation in Spain reached last month 9.8%. The worsening situation prompted a 20-day transport sector strike. This mobilization has led to a shortage of food products in many supermarkets and supply difficulties in factories.

Politicians are rushing to propose relief measures, but the protracted fighting and the dramatic evolution of the war are prompting calls for tougher sanctions against Moscow. Fresh reports of killings in Boutcha, a suburb northwest of kyiv, are reviving the idea of ​​an embargo on Russian energy imports. This radical proposal would plunge the EU into further economic chaos.

Germany, strongly dependent on Russian gas and oilis among the most reluctant countries to take such a sanction. Berlin believes that the shock would be too heavy for its economy.

German industry sees the risk of companies facing existential difficulties due to energy prices or due to a halt in Russian exports of energy raw materials“, specifies in a statement to Euronews Joachim Lang, director general of BDI, the federation of German industries.

Already, some energy-intensive companies are being forced to curtail production due to exorbitant gas and electricity costs.

I’Germanyeconomic engine of the EU, now faces the risk of recession”substantial“, warns the council of wise men of the government. These economists revise downwards their forecasts of growth for 2022 passing from 4.6% to 1.8%. They note that pre-pandemic levels will not be reached until the third quarter of this 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 disappear and that the alternatives entail additional costs.

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

The shadow of stagflation

The dark turn of events inevitably brings back the dreaded specter of stagflationa period characterized by economic stagnation, high inflation and high unemployment.

The term stagflation originated in the 1970s, when oil-producing countries declared an embargo following the Yom Kippur War. This decision caused an extraordinary increase in production costs. The crisis led to an oil shock which combined a rise in inflation and a decline in the economy.

Fifty years later, a new energy crisis threatens to relaunch stagflation, even if the phenomenon could turn out to be temporary.

It’s a nightmare because you have negative growth but, at the same time, high inflation. So you should raise interest rates to fight high inflation, but you should keep monetary policy very loose because the economy is doing badly“, analysis for Euronews Peter Vanden Houte, chief economist at ING Belgium.

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

According to forecasts, the ECB could end its quantitative easing program during the summer and approve a first interest rate hike in the fourth quarter of this year.

However, the latest economic indications could accelerate the timetable. “Upcoming data does not indicate a significant risk of stagflation“, explained Christine Lagarde in remarks delivered before the publication of the inflation rate for March.

An additional risk

Inflation should be fueled by a impending food crisis worldwide. Ukraine and Russia are considered the breadbaskets of the world, producing about 30% of food products staples such as wheat and corn.

Last week, David Beasley, director of the United Nations World Food Programme, told the Security Council that the conflict in Ukraine would create “disaster on top of disaster“and could trigger the worst global food crisis since World War II.

In Brussels, EU officials are seeking to reassure citizens by stressing that food supplies are guaranteed, but medium-term responses are needed to avoid shortages. According to March inflation data, food, alcohol and tobacco rose 5% year on year, compared to 4.2% in February. Unprocessed foods rose 7.8%, driven by seasonal factors and higher transportation and fertilizer costs.

The food crisisthe power shortagethe supply chain disruptions and all the other potential ramifications of the war in Ukraine portend a long and difficult road for the European economy. In this context, inflation may no longer be a temporary phenomenon as many had predicted before the invasion. On the contrary, it could become a long-term challenge.

We also have to take into account that we will have some side effects now that energy and food prices are high. Ultimately, this could affect other prices as well. High energy prices will also make other goods and services more expensive“, warns Peter Vanden Houte. According to him the war in Ukraine “more of a game changer“than covid-19.

All in all, let’s say that lowering 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.

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