Winter in Europe is likely to be long and fatal for several governments, including the German coalition. German Chancellor Olaf Scholz is struggling in the polls. On Sunday, he won a regional test election that gave him some air. The Social Democrats of the SPD won 33% of the vote in the regional state of Lower Saxony, the second largest in Germany, which they have led since 2013. Nevertheless, the SPD is down compared to the previous regional election in 2017, when it recorded 36.9%. The Conservatives also posted a result far below their 2017 performance (33.6%). The far right seems to have benefited, capitalizing on the frustration and concern caused by the energy supply problems and the soaring prices: the Alternative for Germany (AFD) reached 11.5%, almost double the previous election. His latest plead for a rapprochement with Russian President Vladimir Putin by believing that Germany cannot do without Russian gas.
The European position on the Ukrainian conflict is becoming increasingly difficult to hold in the face of public opinion worried about the general rise in inflation. Price increases in the euro area have surpassed those in the United States. The gap widened in September, when Europe-wide inflation reached 10%, while in Germany, it accelerated to 10.9%. European wages have risen more slowly than American wages. As a result, inflation weighs more on living standards in Europe than in the United States, where many workers have earned wage increases in tight labour markets.
Beyond the figures, Europe has different inflation than the United States. Inflation is almost entirely imported via soaring commodity prices rather than fuelled by robust consumer spending and tight labour markets. This distinction has significant implications for policymakers. It means that European central bankers have less capacity to tackle inflation through a policy of raising interest rates. On the opposite, an increase in interest rate could damage economic growth.
The Fed’s action will likely have its effect in a few months, limiting the rise in prices in the United States. The situation is different in Europe. The energy crisis caused by the Ukrainian conflict will not stop this winter. Even if shipments of liquefied gas are secured, the price paid to finance economies, especially that of Germany, will be multiplied by two or three. All the competitiveness of the German industrial tool is at risk. The ECB is helpless in the face of this scenario.
Fiscal policy is also diverging. The United States has withdrawn its stimulus measures. In contrast, European governments are forced to support their economy, to cushion the blow of soaring energy bills. These measures would represent at least 5% of GDP this year. As a result, the combined budget deficit of the euro area is expected to be larger than that of the United States this year.
Despite a likely recession, particularly in Europe, energy prices, especially oil, are expected to return to their highs. The lack of investment in the oil sector, an uncertain geopolitical environment, and the West’s willingness to limit access to Russian oil should more than compensate for the possible drop in demand. Widespread rising rates and high debt levels are also expected to weigh on the most fragile countries, particularly the emerging world and Eastern Europe. Given these factors, it is likely that the euro will continue to lose ground against the dollar.
Europe is entering an uncertain period from which it will not emerge unscathed.