The fires of inflation were kindled in the euro zone after demand forces came back strongly from the pandemic, and they started to spread when the Ukr
The fires of inflation
were kindled in the euro zone after demand forces came back strongly from the
pandemic, and they started to spread when the Ukraine conflict sparked a surge
in food and energy prices. The region has simultaneously been fending off a
slowdown in economic activity since 2022, recording minimal growth in the first
two quarters of this year.
When these two things
happen together, economists know to mention the word “stagflation”, which
refers to the bitter combination of high prices and a weak economy. It’s bitter
for central banks because, if they approach the problem by hiking interest rates
to snuff out inflation, the result could be a deterioration in unemployment
levels. If, on the other hand, they elect to cut interest rates to jumpstart
the economy, what could come out is more inflation.
It’s also bitter for
consumers because, just when their budgets are squeezed the most, the cost of a
trip to the grocery store climbs up even higher. It happened back in 1980 in
the USA, when Americans were faced with the twin challenges of, both enormous
inflation of 14.6% and heightened unemployment at 14.5%, at the same time.
In August this year,
Capital Economics’ Andrew Kenningham said, “I think most people would agree
that it is already a reality in Europe”, referring to stagflation. Not everyone
agrees, however. In September, the European Commission’s Paolo Gentiloni insisted
that, “It’s too soon to say” this is the scenario facing the continent. Let’s
spend a couple of minutes weighing up the issue.
Germany
Germany showed its resilience
in enduring last winter’s economic downturn, but found itself unable to grow in
Q2 2023, held back by lame manufacturing demand. Even the optimistic Gentiloni
admits to the dire impact of this trend on a broad scale. “If the largest
economy in the union is in negative – slightly negative – growth, this is
affecting everyone”, he said. Q3 kicked off with another monthly drop in
factory orders – the largest drop since 2020. Two other burdens Germany is carrying
are the light tug of Chinese demand and its unsolved energy shortage.
The ECB
At their September
meeting, the European Central Bank (ECB) went ahead and hiked interest rates
for tenth consecutive time. It isn’t that inflation hasn’t been responding to
their bitter medicine, because it’s consistently been coming down this year.
The trouble
is that, with the labour market so strong, services demand so high, and
companies pushing their revenues ever upward, prices have not come down as much
as hoped.
The central bank also
renewed its economic forecasts in September, and not for the better. Their new call
for euro zone growth for this year was 0.7%, down from 0.9% three months
before. Their predictions for growth next year and in 2025 also
declined. As to inflation forecasts for 2023 and 2024, they were both revised
upward, confirming stagflation worries.
Other Headwinds
The ongoing Ukraine
conflict presents a threat to Europe’s economy in particular, “given its
proximity, both in terms of additional inflammatory commodity shocks and wider
instability in the region”, explains Lan Ha of Euromonitor International. She
also notes that Russia’s recent withdrawal from the Black Sea grain deal and
the advent of unfavourable weather conditions might further exacerbate
inflation rates.
Another issue is that
the euro economy may not get the push it needs from consumer demand. “Consumer
confidence is a little shaken right now and consumers are tightening their
purse strings”, says Pattern’s Dallin Hatch.
At the end of last
year, Deutsche Bank predicted the euro region would taste stagflation this
year, and that a recession would set in in Q4, continuing into Q1 2024. They
even used the word “polycrisis” in relation to the euro economy, by which they
meant “interacting crises of different origins whose costs are greater than the
sum of their parts”. One potential headwind they mentioned was political
instability that may erupt from all the economic pressure building within
European countries.
Chugging Along
Putting Germany aside
for the moment, there was a pullback in services demand in France and Spain in
August. Still, those nations are expected to be forces for the positive in
Europe’s struggle to grow in months ahead. As to the Netherlands, the European
Commission, in September, slashed their forecast for this year’s growth down
from 1.8% to 0.5%, which indicates a fair deal of pessimism. The Commission
went on to warn that “the impact of tight economic policy is set to continue
restraining economic activity” in the euro zone into 2024.
Even the forex market
seems to be conspiring against euro zone growth, because the euro has recently
been losing strength against the US dollar. Forex traders driving this trend
have been spying an economic slowdown ahead for both Europe and China.
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