Hopes for a “mild recession” in Europe this winter have been abandoned by Deutsche Bank strategists, who have dramatically slashed their 2023 growth forecasts.
The bank now expects EU-area growth to decline 2.2% in 2023, from a previous forecast for a 0.3% decline. Such a peak-to-trough decline would be 50% bigger than that of the euro crisis, though only half as big as the one seen during the 2007-09 recession, noted the economists.
That downgrade comes after the indefinite closure of the Nord Stream 1 pipeline for Russian gas into Europe, that was announced in early September. The cutoff has added “further potential upside to inflation and downside to growth,” said a team led by Peter Sidorov, senior economist on Wednesday.
And even amid the EU’s beefed-up response to help member states ease pressures from elevated prices, “demand for energy needs to decline and the baseline call we made in July for a mild recession this winter is now too benign,” said Sidorov and the team.
“Upside to our view may emerge if fiscal shielding proves very effective or gas prices fall markedly in 2023. But there are also factors that could result in more downside: a colder winter or greater amplification of the competitiveness shock,” said the economists.
The bank’s core forecasts for the EU’s harmonized index of consumer prices is unchanged at 3.8% for this year and 4% for 2023, which they say is hawkish. They see downward pressures such as easing energy inflation and slower growth offset by further supply-chain disruptions due to rationing, tight labor markets keeping wage pressures high and a weak euro.
Deutsche Bank’s gloom comes as Russia appeared to escalate its seven-month war in Ukraine on Wednesday, with President Vladimir Putin calling up 300,000 reservists, and saying all means would be used to defend Russian territories.
The common currency
EURUSD,
which has been hovering around parity since late August, fell 0.5% to $0.991 on Wednesday, while European natural-gas futures jumped to 223.76 euros per megawatt hour (MWh). A year ago that gas price traded at around 34 euros MWh.
The Deutsche Bank economists said they are sticking to expectations for the European Central Bank deposit rate to top out at 2.5%, but that that call comes with two-sided risks.
“If the recession drags on jobs and inflation expectations more than expected, ECB hiking could be stopped out at c.2%. We see the balance of risks skewed to the upside of 2.5% given our concerns about inflation persistence — underlying inflation and second-round effects,” said Sidorov and the team.
The economists explained what they see as a persistent competitiveness threat from the gas crisis. First, countries will see output losses from gas consumption cuts and this will amplify through supply chains. The drag from higher energy prices may then hit real incomes, then comes the uncertainty shock and finally second-round impacts via trade.
“The near-term impact this winter will be most affected by the extent of rationing — whether through enforced cuts or price-based mechanisms — as well as uncertainty effects on consumer and firm behavior,” they said.
And while the impact of gas demand cuts has been moderate so far, Deutsche Bank warns it will worsen this winter as countries move into the heating season. They see Germany and Italy most at risk, given the reliance those countries have had on Russian gas. German GDP is expected to drop 3.5% in 2023, and Italy is forecast to see a 2% decline, with a recession and higher rates also a threat to Italian stability. General elections will be held September 25.
While less impacted by a gas shock, countries such as France and Spain will still be exposed to a “deepening real income squeeze, competitiveness of higher energy prices and contagion via trade.”
The economists seemed unable to see any near-term light at the end of the tunnel.
“Beyond the winter, the expected U.S. recession next year and the tightening of
financial conditions on the back of the ECB’s more front-loaded hiking cycle will
limit the speed of the recovery during the remainder of 2023. We see quarterly
growth moving above potential only in Q2 2024,” they said.
