Ukrainian troops have launched an impressive offensive in recent days, reclaiming some 8,000 km2 of territory at a pace that could force Russian President Vladimir Putin to rethink his strategy and objectives in the six-month war.
However, even if the conflict continues to favor Ukraine, Europe is unlikely to escape recession this winter given the energy crisis triggered by the February invasion.
“I don’t think all of a sudden Ukraine will pull Russian forces out of its territory, the war will end, and Russian gas flows to Europe will resume. [e] Prices will come down,” said Neil Shearing, Group Chief Economist at Capital Economics. “That won’t happen.”
Natural gas costs in Europe fell nearly 50% after hitting a new record in late August. They fell 20% in the last week alone as Ukrainian troops advanced. But they are still 460% higher than a year ago after Russia announced the closure of the Nord Stream 1 pipeline, crucial to European supplies.
Putin’s next moves are still unpredictable as his forces retreat. It could cut off the remaining gas supplies that continue to Europe via Ukraine, exacerbating the region’s energy crisis, or, if it feels cornered, try to change the situation in a more worrisome way, such as a political threat.
“We have to be a little bit humble about our ability to predict what’s going to happen,” Shearing said.
Europe is rushing to build energy reserves so that homes and businesses can maintain access to energy and heat as the weather turns colder. The initiative has been successful so far with 84% efficient storage facilities at enormous cost.
Governments have launched generous support packages to protect consumers and small businesses from the effects of rising prices. The UK and Germany, along with other EU countries, have announced more than €500 billion in spending subsidies and other interventions to mitigate the impact.
However, a contraction in economic activity in the coming months seems inevitable, economists warn. UK manufacturing stagnated in the three months to July, according to data released on Monday. Meanwhile, Germany’s Ifo cut its growth estimate for Europe’s largest economy.
“We are heading towards a winter recession,” said Timo Vollmerschaser, head of the Institute for the Future, on Monday.
Most analysts expect the European economy to contract in the last quarter of 2022 and the first quarter of 2023. What happens after that remains uncertain.
It all comes down to gas
Europe’s dependence on natural gas from Russia is vulnerable as the market experiences unprecedented volatility when it declines this year.
Russia is now delivering 78% less gas to the region compared to the same period last year, according to Kaushal Ramesh, who is in charge of gas supply research at Rystad Energy.
As European buyers roamed the world in search of alternative sources, prices rose. Rising energy prices have dramatically changed the economic outlook, dramatically raising household costs, forcing people to cut other expenses, and forcing heavy industries to close factories.
“Russia’s gas supply cuts over the summer and the sharp price hikes they caused are wreaking havoc on the post-Covid-19 economic recovery,” Vollmershauser said. We don’t expect normalcy to return until 2024.
Germany’s closely watched ZEW economic conditions indicator fell again in September, a sign that prospects for the economy are increasingly gloomy, according to data released on Tuesday.
“The outlook for the next six months has become even worse,” said Achim Wambach, president of ZEW. “The prospect of winter power shortages has made the outlook for large sectors of German industry even more negative.”
China’s economic slowdown is also bad news, he said. The housing crisis and ongoing Covid-19 restrictions could affect German exports.
The success of Ukraine’s counteroffensive “shows that there is still a small probability of a positive scenario in this sea of negative economic prospects,” said Carsten Bresky, global head of macro research at ING.
Even so, he cautioned, “it is difficult to foresee any scenario in which energy prices will fall significantly in the coming months.”
Rystad Energy’s Ramesh predicts major risks that pressure on gas prices may return. They landed last week on hopes that the European Union would soon announce stronger intervention in the market. But fundamental concerns about supply and demand haven’t changed, and low liquidity in the market means big price swings in either direction are possible.
“We are not at a dead end when it comes to pricing,” Ramesh said. “There are a lot of positives in my view.”
What follows
It depends on how cold it gets during the winter months. If temperatures drop significantly, energy demand rises, and prices rise, economic conditions could worsen dramatically.
Government action is expected to ease the crisis. The UK has pledged that the average British household will pay no more than €2,885 for their energy over the next two years. It will support companies, charities and public sector organizations with their energy expenditure for the next six months. Germany recently announced a €65 billion package to support energy costs for households and businesses.
But most economists think the energy problem is so deep that even hundreds of billions of euros won’t be enough to avoid recession. It is also unclear what proportion of the commitments given will ultimately be implemented.
“Fiscal support reduces the severity of recessions, but does not eliminate them entirely,” said Shearing of Capital Economics.
As higher energy prices push up inflation, there is also pressure on the European Central Bank, which raised its benchmark interest rate to an unprecedented high last week. Rising borrowing costs will be another drag on the European economy.
The Bank of England is also acting aggressively without easing restrictions, predicting in August that it will enter recession by the end of the year.
However, options are limited as central banks seek to control inflation. The ECB now expects inflation to average 8.1% this year and 5.5% in 2023. The Bank of England last forecast UK inflation to remain above 13%, although that estimate could be revised downwards as government aid is implemented.
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