The scourge of inflation means a tough year ahead for Europe

INFLATION HAD been high for a while. But then, in the summer of 1922, prices started to climb dramatically. A loaf of bread that had cost 0.30 German marks in 1914 was selling for 8 marks in June 1922 and 160 marks by the end of that year. What followed in Weimar Germany was hyperinflation, which led to more than just the collapse of the currency. As Stefan Zweig, a novelist, put it in 1942, “nothing has made the German people so bitter, so hateful, so ripe for Hitler as inflation.”

Exactly 100 years later, Europe is grappling again with high inflation, caused by a European war. Hyperinflation is, fortunately, a very remote prospect: the economies of Europe are strong, and policymakers are committed to keeping debt sustainable and tackling inflation. But in 2023 the full economic impact of price rises, and the energy crunch that largely caused them, will be felt across Europe—leading first to a recession and then to a painfully slow recovery.

Start with energy. In its war against Ukraine, Russia has wielded energy as a weapon against Kyiv’s Western backers, slashing gas exports to Europe and sending gas prices skywards. Unfortunately, many French nuclear-power stations were offline for repairs, and a drought across Europe reduced the availability of hydroelectric power. Plants running on eye-wateringly expensive gas had to fill the gap.

In 2023, energy will remain expensive. Europe has added to its import capacity for liquefied natural gas, but global supplies will not increase by much. Gas-storage facilities are almost full and, thanks to a warm autumn, will not be completely empty by spring. But oil-producing countries seem determined, despite diplomatic pressure from the West, to keep oil scarce and dear. And French nuclear plants will resume output, but not by enough to bring power costs down very much.

That will leave inflation higher than many had hoped. True, as raw energy prices stop rising, year-on-year comparisons mean inflation will shrink almost mechanically throughout 2023. But some energy prices are capped or set using long-term contracts, and so have yet to rise fully. In the rest of the economy, the energy-price shock will continue to push prices up. Wages will increase to make up for lost real income, adding to firms’ costs. Businesses will pass higher costs on to customers to protect profit margins. And rising prices for services, which are largely unrelated to energy, will take time to slow.

Consumers and businesses will feel the brunt and start to hold back. In 2022, a year of post-covid recovery, pent-up demand for sunny holidays and fancy restaurants boosted the economy. Industry benefited from overflowing order books from the post-covid surge in demand and the supply-chain disruptions that came with it. But in 2023, household budgets will face a double whammy: higher energy bills and increased mortgage payments as interest rates remain high to fight inflation. Firms will also be squeezed, and so will cut back on investment. All of this will tip Europe’s economy into recession.

Unlike in previous slumps, the global economy cannot come to Europe’s rescue. Export orders for its industry will remain low during 2023, as higher interest rates, the global energy crunch and the strong dollar weaken growth and demand throughout the world. Only once energy prices have come down, and inflation in America has been brought under control, will global growth be able to support Europe’s recovery. But that will not happen in 2023.

The bright spot is the labour market. Europe’s economy is increasingly short of workers, as older cohorts retire and younger, less populous generations enter the workforce. Firms will think twice before making staff redundant, and generous support schemes will help preserve jobs. Many consumers will worry about their energy bills and mortgage payments in 2023, but few will fear losing their jobs.

Public support for households and businesses will help prevent a deeper recession in Europe in 2023. Governments across the continent are trying to shield their voters from the impact of unaffordable energy bills. That will put a floor under their real incomes and limit the economic fallout of the energy crisis. It should also help reduce the political divisions that history teaches inflation can bring.■