Will the war in Ukraine usher in a new recession in Europe?

The post-pandemic economic downturn—worsened by the Russian invasion—will force European governments to renew their fiscal support

April 08, 2022
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Image: DPA Picture Alliance / Alamy Stock Photo

Will Europe go a step further and implement an immediate ban on Russian oil and gas imports? This is now the big question, after the brutality in Ukraine prompted a further round of economic sanctions. The US has already banned oil imports from Russia and the UK intends to do so by the end of the year. The EU has announced a ban on coal, the first step in tackling overdependence on energy imports from Russia. It also intends to reduce reliance on overall Russian energy imports, including also of oil and gas by two-thirds by the end of the year, cutting it out completely by 2027. The International Energy Agency has produced a ten-point plan to wean the west off Russian energy.

But is that at all achievable? The answer is yes, but at a cost—and that cost will be greater if there is an outright blockage of gas imports. The embargo could be imposed by either side: Russia is now insisting on being paid in roubles and could decide to cut supplies if that request isn't met. 

The position for the west is not a simple one. There is already disagreement on the rouble condition—with Hungary's newly re-elected Prime Minister Viktor Orbán breaking ranks with the rest of the EU and declaring that he is prepared to comply with the Russian request. And the European Parliament has been presented with analysis that shows that while the EU has so far transferred some €1bn in aid to Ukraine it has also been paying around €1bn a day to Russia for energy imports since the start of the war. 

That clearly isn’t a sustainable state of affairs. It is no surprise that MEPs seem to be pretty united in urging a complete ban on Russian oil and gas as the next step.

And that may happen. But who else will lose out? On energy, the level of dependence on Russia varies hugely from country to country. Germany has long been reliant on cheap Russian gas to power its vast industrial base. There was little incentive (except in the pursuit of environmental objectives in recent years) to do anything different. That dependence leaves Europe vulnerable as the conflict unfolds. But one reason why Lithuania has found it relatively easy to make the decision to stop importing oil and gas from Russia is because its infrastructure allows for more liquefied natural gas (LNG) from elsewhere. Meanwhile Germany, one of the most exposed to any cut in supplies from Russia, will be starting from scratch in building LNG terminals and facilities. And Berlin’s decision to abandon nuclear by the end of this year is an added source of weakness and division in the current EU position, vulnerable to exploitation by the Russians.

Meanwhile, the war is making everyone revise their growth forecasts downwards. Even for countries like the UK, which relies less than others on Russian fossil fuels, the price hikes and uncertainty ahead are reflected in the present cost of living crisis, with lower growth and higher inflation than what was expected just a few months ago. The Eurozone is seeing the highest inflation for 40 years—with prices in Italy, for example, up an estimated 6.7 per cent in March on a year-on-year basis. In Germany, on the same basis inflation seems to have picked up from 5.1 per cent in February to 7.3 per cent in March. And while manufacturing and consumer spending has been reviving across most of the EU, albeit at a gentle pace after the strong 2021 bounceback, overall economic sentiment has now plummeted.

So what next? An immediate ban on oil and gas from Russia would hit EU growth further. Some forecasts suggest that growth in Germany may fall by 3 per cent in 2022—but even these are considered too optimistic by Chancellor Scholz.

It could be worse. The rest of Europe will suffer too, even those with access to wider energy sources, if Germany—usually a locomotive for growth—stutters. And all know that stepping up the drive on renewables, increasing fossil fuel exploration or building new LNG terminals will be expensive. Energy prices will continue to rise for a while, at any rate, as shortages develop. Germany has even hinted that fuel rationing may be necessary to tackle the energy crisis.

Economists were suggesting that a combination of high inflation and slow growth—“stagflation”—was on the cards even before the start of the war. Sharply rising prices were driving higher interest rates and a gradual withdrawal of the monetary and fiscal support seen during the pandemic, hurting pockets and slowing down activity. But it is difficult to imagine that governments will stand idly by now that the war has added more uncertainty and increased price pressures even further, raising the prospect of actual recession.

So expect a renewed fiscal support effort and a rethinking of monetary policy in the EU. Meanwhile the US, a lot more energy self-sufficient, can carry on with its own monetary tightening unhindered—despite what that will mean for the dollar’s competitiveness.