Filenews 29 July 2022
By Eleftheria Kourtali
Citigroup made a significant change in its estimates of the course of the European economy today, stressing that the worst-case scenario is now becoming the main one for the region, with the deep recession hitting with certainty. As she notes, her recent estimate of a mild recession in the eurozone became overly optimistic with gas prices having risen by 30% and key economic indicators indicating that a recession is coming such as that of 2011/12 or even 2008/9. Policy action can still prevent the worst, but a more intense recession and prolonged weakness will be difficult to avoid anymore.
Thus, Citi reduces its GDP growth forecasts for 2023 to -1% for the euro area and -2% for Germany, while a recession of 0.9% is forecast for Italy as well. A return to the pre-pandemic course of economic dynamics seems unlikely unless monetary-fiscal policy coordination brings about a significant acceleration of investment, as it underlines.
A deep recession is coming
In the wake of the intensifying conflict between Russia and the EU, but also of the protracted effects of the pandemic and tighter economic conditions, the main economic indicators have hit new lows and show a much worse outcome than a mild recession.
Over the past week and a half, almost all indicators of euro area economic activity have taken a decisive turn for the worse. The composite PMI fell to 49.4, the European Commission's Economic Sentiment Index (ESI) to 99.0. Both were much weaker than forecast and surpassed critical levels (50 and 100, respectively) for the first time since February 2021. Both remained far from the territory of the recession, which we see at 48 and 95, respectively, but other key indicators indicate that this is unlikely to last.
In July, Germany's Ifo index, a good indicator for investment, reached the bottom of the 2008/9 crisis. The growth rate of the limited M1 money supply (cash and overnight deposits of households and non-financial corporations), adjusted for inflation, fell below -1% year-on-year in June. The last time this happened in 2008, euro area GDP fell at a rate of 1% per annum three quarters later.
There are many headwinds for the economy that are global in nature, Citi points out. These include the effects of the pandemic, such as ongoing supply chain disruptions or a significant change in consumer demand. The global tightening of financial conditions due to expectations of central bank interest rate hikes also play a role.
But the geographical distribution of the shock clearly shows that the shock comes from northeastern Europe. This suggests that the main driver of European development weakness is ultimately the conflict with Russia. It has caused a sharp increase in energy costs, increased uncertainty, caused new supply disruptions and reduced trade. Especially the first two opposite winds now significantly exceed the expectations that Citi had immediately after the invasion of Ukraine at the end of February. Thus, avoiding the recession is no longer the main scenario.
The plunge in consumer confidence to new historical lows in July remains particularly impressive, the US bank points out. Although business confidence is starting to follow consumer confidence, the gap between the two remains historically high. "We are particularly concerned by the data from the German GfK survey this week that households may be increasing savings. The survey tends to correlate well with Germany's real household saving rate and currently shows a recovery in savings from around 12% of disposable income almost to the pandemic levels of 20%, as it points out. This time, it is voluntary and not forced savings, which makes it less likely that it will be spent in the short term. It could mean that households are responding to rising prices by saving more for their retirement. Preventive savings in a recession and fears about job security can also play a role.
"The evidence is therefore overwhelming that Europe is heading towards recession, and not just a mild recession," Citi warns.
The gas crisis
The sharp decline in Russian gas supplies has increased prices and uncertainty. Mandatory reductions in gas consumption in Germany combined with the EU solidarity plan would be costly in terms of production, but they will overturn control and undoubtedly improve the current path of maximum uncertainty.
Unfortunately, however, the EU solidarity plan for gas did not have the desired downward impact on prices (TTF prices increased by 30% above €200 per MWh between 20 July and 27 July). At this price, the cost of Germany's gas consumption in 2021 would be almost €200 billion (just under 6% of GDP), compared to just €10 billion (0.3% of GDP) in 2019. For the EU as a whole, costs will increase from 0.4% of GDP to almost 7% of GDP, for Italy from 0.4% of GDP to 9% of GDP. Long-term delivery contracts, consumption reductions of around 10% already this year as well as the possibility of passing on part of the cost increase through export prices are somewhat reducing the impact, but the change in Germany's trade balance from €212 billion in 2019 to possibly around €30 billion this year, that the protection is not great.
The worst-case scenario became the basic
A mild détente or the end of the conflict with Russia now seems unlikely. The most likely scenario now is what Citi had recently positioned as the worst - either a somewhat controlled deep recession or a further EU partition that would leave Russia in control of the crisis, prices and uncertainty at high levels and the economy possibly in a very deep recession.
If it tries to replace Russian gas and reduce consumption, and Russia reduces supply to very low levels, Europe will likely not reach 90% storage levels by the autumn. When consumption increases seasonally in October and November, it could be too late for mild energy rations, leaving Europe dependent on significant gas flows from Russia. The conflict in Ukraine could then trigger further escalation as Russia capitalizes on this report. In anticipation of this, business and consumer confidence has already plunged and may remain close to record lows, with gas prices at record highs.
However, as Citi points out, by directly reducing consumption, including the mandatory pass and the implementation of the solidarity plan between EU members who are not directly exposed to Russian gas, gas storages could more easily be covered at the 90% threshold by October and an end to Europe's dependence on Russian gas during the winter. The economic blow in this case is still 1-2% of GDP compared to scenarios where a decrease in consumption can be avoided, that is, a deep recession is inevitable. But if the EU reduces gas consumption before any Russian move to cut off gas, Citi estimates that gas prices will fall and uncertainty will fade. In this scenario, Europe and the US could more easily impose a price cap on Russian gas as well, as reportedly scheduled for December, or impose tariffs on gas imports from Russia.
"A return of the GDP path to pre-pandemic levels now seems unlikely unless coordinated monetary and fiscal policy unleash a very large increase in investment. Given the ECB's focus on inflation, Germany's focus on fiscal discipline and the limitations of rising borrowing costs in the periphery, it will not... we were putting our money into such a development," Citi concludes.
Source: Capital.gr
