The European economy is facing strong headwinds as the energy crisis fueled by the Russia-Ukraine conflict takes its toll on the eurozone, driving up inflation, squeezing household incomes and weakening consumer confidence. Experts said such downward pressure is likely to increase as winter approaches.
In its latest economic forecast, the European Commission projects that the economy of the European Union will grow 2.7 percent in 2022 and 1.5 percent in 2023. Growth in the euro area is expected to be 2.6 percent in 2022, moderating to 1.4 percent in 2023. All the predictions are much weaker than the spring forecast.
Annual average inflation is now projected to hit what would be a historical high of 7.6 percent this year in the euro area and 8.3 percent in the EU, an upward revision of 1.5 percent from the previous forecast, according to the commission.
In a move to tackle soaring inflation in the eurozone, the European Central Bank raised interest rates for the first time in 11 years by 0.5 percentage point on July 21.
John Beirne, vice-chair of research at the Asian Development Bank Institute, a think tank, and a former economist at the European Central Bank, said the economic outlook for Europe is strongly linked to the energy market implications of the Ukraine conflict.
"A higher cost of living, disproportionately affecting low-income households, presents challenges for European policymakers in an environment of a weaker growth outlook," he added.
Beirne pointed out that stagflation is a key concern in Europe, with high inflation driven by negative supply shocks in energy markets and global supply chains hampering economic growth via consumption and production.
Michel Ruimy, an economist and affiliate professor at ESCP Business School, said: "The combination of low growth and high inflation raises the specter of stagflation. This situation is likely to make the European Central Bank's task even more difficult."
To counter inflation, the European Central Bank can raise its key interest rate, but a monetary tightening will increase the cost of borrowing for businesses and households, which could ultimately weigh on consumption and investment, Ruimy said.
The European Commission warned in its latest analysis that the EU economy remains vulnerable to developments in energy markets, given its reliance on Russian fossil fuels. The concern was intensified when Russia shut down the Nord Stream 1 pipeline, which carries Russian natural gas to Germany, for a 10-day maintenance period. Much to Brussels' and Berlin's relief, the gas supply was resumed on July 21, albeit at a lower capacity.
"Engaging in an 'arm wrestling match' with a country on which one depends to cover one's energy needs, especially gas, is the unique situation in which the European Union finds itself, which will have to pay more for its energy, pollute more and ration more," Ruimy said.
Beirne said: "With Russia accounting for around 40 percent of Europe's gas imports and around 25 percent of crude oil, a complete shutdown heavily increases the vulnerability of the continent to an energy crisis. The exposure will become more pronounced as the colder months approach."
Analysts said the situation in Ukraine has highlighted key areas in which structural reforms need to be ramped up at the EU level.
"Diversifying the energy supply mix in Europe, particularly toward renewable and sustainable energy, would help to mitigate against exposure to sharp commodity price shocks in specific markets. Fiscal policies aimed at improving energy efficiency are also an important aspect," Beirne said.
European economic woes have also prompted its currency to slip, with the euro hitting parity against the dollar, falling to its lowest level since December 2002.
Christopher Bovis, a professor of international business law at the University of Hull in the United Kingdom, said the fact that the euro has hit parity with the US dollar for the first time in 20 years is an acute indication of the economic deterioration of EU economies.
"The gradual weakening of the euro is attributed in the stagnation of major eurozone countries and the limited gains in productivity (amid COVID-19 recovery). The US dollar has emerged again as the preferred reserve currency, a fact which has contributed to the parity currency environment," Bovis said, adding that the eurozone economies will have to realize that parity of the euro with the US dollar is the new norm.
However, David De Remer, an assistant professor of economics at Nazarbayev University Graduate School of Business in Kazakhstan, said that euro-dollar parity is not just due to the euro's weakness, but also the dollar's strength.
"The case for temporary US dollar strength is that the Federal Reserve just raised rates aggressively and the current situation of higher US interest rates will not last long, but euro weakness will instead persist if geopolitical instability worsens.
"The euro-dollar parity, however symbolic, is not of substantial macroeconomic consequence, aside from continuing the trend of euro depreciation that has been ongoing since 2008. European goods and tourism again become cheaper for Americans, and Europe will import some inflationary pressure from the US," he added.
Bovis said, "The future of the European economic recovery is highly dependent on the situation in the energy sector.
"The energy security issue which has emerged as the main shortcoming of the EU is the primary pathogen case of the weakening of the EU currency," he added. "Eventually, energy concerns will be rectified, but for the first time the energy sector has played such a catalytic role in destabilizing a currency."