Russia’s war in Ukraine is delivering a “supply shock” to the eurozone economy that will push up prices, slash growth and drain consumer and business confidence, says Christine Lagarde, president of the European Central Bank.
Presenting her gloomiest assessment yet of how the invasion will hit the bloc’s economy, Lagarde said Europe was “entering a difficult phase” as she outlined how the soaring price of energy, food and manufactured goods would squeeze consumers’ purchasing power. The conflict was “starting to drain confidence”, she added.
“Clearly, the longer the war lasts, the higher the economic costs will be and the greater the likelihood we end up in more adverse scenarios,” she said, specifying that higher energy prices had already cut eurozone income by 1.2 per cent in the fourth quarter of 2021. “That figure would imply a loss of about €150bn in one year,” she added during a speech in Cyprus.
Her comments came as the German government on Wednesday took the first formal step towards gas rationing as it prepared for a potential halt in deliveries from Russia due to a dispute over payments, which could plunge the industrial heartland of Europe into crisis.
The group of economists that advises Germany’s government warned of a “substantial” risk of recession if Russian energy imports were cut off, which could drive inflation in Europe’s largest economy as high as 9 per cent.
The council of economic advisers also slashed its 2022 growth forecast for Germany from 4.6 per cent to 1.8 per cent and raised its inflation prediction from 2.6 per cent to 6.1 per cent.
An EU survey published on Wednesday showed European consumers and businesses have turned much more pessimistic since the Russian invasion last month, fearing it would reduce spending, increase unemployment and raise prices faster.
Meanwhile, Spanish inflation soared to 9.8 per cent in March, its highest level since 1985, rising from 7.6 per cent last month and well above expectations, the country’s statistics office said on Wednesday.
Early regional figures indicated German inflation was set to rise above 7 per cent in March, which would be the highest level since the early 1980s. Economists also expect eurozone price growth to set a new record of 6.6 per cent in March, when those figures are published on Friday.
Investors are betting the ECB will raise rates several times and lift them back up to zero by the end of the year. They increased those bets on Wednesday, sending the German 10-year bond yield up to 0.68 per cent.
The ECB this month responded to soaring inflation by outlining plans to stop net bond purchases by September, setting the stage for it to raise rates this year if inflation stays high. Lagarde said on Wednesday: “The best way that monetary policy can navigate this uncertainty is to emphasise the principles of optionality, gradualism and flexibility.”
But the ECB president also signalled EU governments could do more to support the economy, saying: “Europe needs a plan to ensure that the necessary investment comes online as quickly and smoothly as possible, with public and private finance reinforcing each other.”
The European Commission said its economic sentiment indicator fell 5.4 points to minus 108.5 this month, its lowest level for 12 months, “mainly due to plummeting consumer confidence”.
Confidence fell among companies in industry and retail trade but was steady in services, the commission said. Inflationary pressures intensified as companies’ selling price expectations rose to a record high.
The outlook for the labour market also worsened as consumer unemployment expectations rose sharply and employment expectations dipped in most sectors except for services.