Ukrainian forces have launched an impressive attack in recent days, retaking some 8,000 km2 of their territory at a rate that could force Russian President Vladimir Putin to rethink his strategy and objectives in this six-month war.
But even if the conflict continues to swing in Ukraine’s favour, Europe is unlikely to escape recession this winter, given the energy crisis triggered by the February invasion.
“I don’t think Ukraine will suddenly push Russian troops out of its territory, the war will end, Russian gas flows to Europe will resume. [e] prices are falling,” said Neil Shearing, chief economist at Capital Economics. “That’s just not going to happen.”
Natural gas costs in Europe have fallen by almost 50% after reaching a new record at the end of August. In the past week alone, they fell by 20% as Ukrainian troops advanced. But they are still about 460% higher than a year ago, following Russia’s announcement that it would close the Nord Stream 1 pipeline, crucial to Europe’s supply.
Putin’s next moves are also unpredictable as his troops withdraw. It could cut off the remaining gas supply, which still goes to Europe through Ukraine, exacerbating the energy crisis in the region, or change the situation in an even more worrying way, such as political blackmail, if it feels cornered.
“We should have some humility about our ability to predict what’s going to happen,” Shearing said.
Europe is rushing to build up energy reserves so that households and businesses can keep access to energy and heating when the weather gets colder. The effort has been successful so far, with storage facilities reaching 84% capacity, albeit at a huge cost.
Governments have also launched generous aid packages to try 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.
Still, a contraction in economic activity in the coming months seems inevitable, economists warn. UK production stagnated in the three months to July, according to data released Monday. Meanwhile, the German Ifo Institute lowered its estimate of growth in Europe’s largest economy.
“We are heading for a winter recession,” Timo Wollmershäuser, the institute’s head of prospecting for the future, said Monday.
Most analysts believe that the European economy will contract in the last quarter of 2022 and the first quarter of 2023. What will happen next remains uncertain.
It all comes down to gas
Europe’s reliance on natural gas from Russia, although declining this year, has made it vulnerable as the market experiences unprecedented volatility.
Russia now supplies 78% less gas to the region compared to the same time last year, according to Kaushal Ramesh, who is responsible for analyzing gas supplies at Rystad Energy.
As a result, prices rose as European buyers roamed the world in search of alternative sources of supply. And rising energy costs have dramatically changed the economic outlook, dramatically increasing housing costs, pushing people to cut other spending and forcing heavy industry to shut down factories.
“Russia’s gas deliveries over the summer and the drastic price increases they have caused are damaging the economic recovery after Covid-19,” Wollmershäuser said. “We don’t expect a return to normality until 2024.”
The close ZEW indicator of the economic situation in Germany fell again in September, according to data released Tuesday, a sign that expectations for the economy are becoming increasingly bleak.
“The outlook for the next six months has deteriorated even more,” said Achim Wambach, chairman of the ZEW. “The prospect of power shortages in the winter has made expectations for major sectors of German industry even more negative.”
The economic slowdown in China is also bad news, he added. A housing crisis and ongoing Covid-19 restrictions could weigh on German exports.
Carsten Brzeski, head of macro research at ING, said the success of Ukraine’s counter-offensive “shows that there is still a slim chance of a positive scenario in this ocean of negative economic prospects”.
Still, he warned that it is “difficult to predict any scenario in which energy prices would fall significantly in the coming months”.
Ramesh of Rystad Energy predicts huge risks that pressure on gas prices could return. They went under last week in hopes that the European Union can announce a strong intervention in the market soon. But the fundamental concerns about supply and demand have not changed, and less liquidity in the market means that large price swings in both directions are possible.
“We are not at a dead end in terms of pricing,” Ramesh said. “There are many positive aspects, from my point of view.”
what is next?
Much depends on how cold it will be in the winter months. If temperatures drop significantly and demand for energy rises, causing prices to rise, economic conditions could deteriorate dramatically.
Government intervention is expected to alleviate the crisis. The UK has promised that the average British household will pay no more than €2,885 for their energy over the next two years. It will also support businesses, charities and public sector organizations with their energy costs for the next six months and possibly longer. Germany recently announced a €65 billion package to support energy costs for households and businesses.
But most economists think the energy problem runs so deep that even hundreds of billions of dollars in aid won’t be enough to get around a recession. It is also unclear which part of the commitments made will ultimately be implemented.
“Fiscal support reduces the severity of a recession, but does not completely avert it,” according to the Shearing of Capital Economics.
As high energy prices fuel inflation, so does pressure on the European Central Bank, which last week raised its benchmark interest rate to an all-time high, while also signaling that more hikes are expected. Rising borrowing costs will be an additional drag on the European economy.
The Bank of England is also reacting aggressively and not lifting restrictions, after forecasting in August that the UK will slip into recession by the end of this year.
However, the options are limited as central banks try to contain the price increases. The ECB now expects inflation to average 8.1% this year and 5.5% in 2023. The Bank of England last forecast inflation in the UK to top 13%, although that estimate could be lowered adjusted as government aid is granted.