EU growth will be “severely impacted” by the disruption stemming from Russia’s invasion of Ukraine, the European Commission warned, as investor confidence dropped sharply in Germany, the union’s biggest economy.
Valdis Dombrovskis, the commission’s executive vice-president, said the commission is expecting 2022 growth to be below the 4 per cent predicted in its most recent forecasts just over a month ago, although it is not predicting the expansion will “completely stop”.
His words, following a meeting of finance ministers in Brussels, came as German investor sentiment fell to its lowest level since the start of the Covid-19 pandemic according to a survey published on Tuesday. The Zew research institute said its economic sentiment index recorded the biggest decline in the 31-year history of its monthly poll of investors, reflecting fears that the EU’s biggest economy could be hit by a recession and soaring inflation as a result of the fallout from Russia’s invasion of Ukraine.
Soaring energy prices, the threat of higher food prices and waning confidence are threatening to derail what promised to be a second strong year of economic recovery from the Covid-19 pandemic in Europe. The EU as a whole returned to its pre-pandemic level of gross domestic product in the third quarter last year and expanded by more than 5 per cent in 2021.
The German economy shrank 0.3 per cent in the final quarter of last year and economists fear the disruption caused by Russia’s invasion of Ukraine could reduce GDP for a second consecutive quarter – meeting the definition of recession.
Zew said its gauge of investor expectations for the German economy had fallen from 54.3 in February to minus 39.3 in March – taking it close to the all-time low of minus 49.5 reached in March 2020 when the pandemic was spreading across Europe. A measure of confidence in German economic conditions fell 13.3 points to minus 21.4.
“A recession is becoming increasingly likely,” said Zew President Achim Wambach. “The Ukraine war and the sanctions against Russia are considerably worsening the economic outlook for Germany.”
The war in Ukraine has sent prices for energy, commodities and food soaring to record highs, pointing to a further surge in eurozone inflation, which had already hit a record high of 5.8 per cent in February.
Christine Lagarde, president of the European Central Bank, said in a speech on Tuesday that the Ukraine crisis would “lower growth and raise inflation through higher energy and commodity prices, the disruption of international trade and weaker confidence”.
But she added that the eurozone economy “should still grow robustly in 2022 thanks to the declining impact of the pandemic and the prospect of solid domestic demand and strong labor markets”.
The commission warned that the impact of the external shocks would vary depending on individual countries’ exposure to Russian energy, their economic structures, geographic location and the degree of flexibility in their public finances.
“So a common response is also about tackling the risk of divergence,” said economic commissioner Paolo Gentiloni said on Monday. “If we remain agile and ready to adjust as needed, we can ensure that the recovery is not totally derailed.”
Following Russia’s invasion of Ukraine the commission signaled it would consider in May whether to extend the suspension of its debt and deficit rules by another year until 2024 – a decision that an increasing number of member states view as inevitable.
Finance ministers discussed proposals including a new EU regime permitting state aid for crisis-struck businesses and emergency cuts to fuel duties.
Some member states have also begun floating the idea of fresh common EU borrowing to raise funds to respond to the crisis – for example, to bolster energy investments that help the EU to wean itself rapidly off Russian fossil fuels, a goal the commission argues could be achieved as soon as 2027.
However, commission officials including Dombrovskis stress that the EU should first seek to fully exploit existing sources of funding – including undrawn loans of around € 200bn that are available under the NextGenerationEU recovery plan.
Asked about the need to support member states that have seen the largest inflows of refugees from the Ukraine crisis, Dombrovskis added that the commission had proposed allocating € 500mn to Ukraine and to neighboring countries hosting refugees.
“We are looking at further ways [of supporting] those countries that are in the front line of the situation, ”he added.