10 Mar 2023 3 min read

Europe’s one-two punch

By James Carrick

Consensus is revising up European growth forecasts on cheaper energy but likely underestimating the impact of tighter monetary conditions.


A ‘one-two punch’ is defined as two bad things happening in succession, such as a jab by a boxer’s left hand followed by a cross with right. The direct blow from Europe’s energy crisis has been less painful than feared, boosting consensus optimism that the economy will rebound soon. But we feel it’s underestimating the impending indirect impact from tighter monetary conditions. 

European energy prices have been on a rollercoaster ride over the past year. Fossil fuel futures prices soared by 9% of GDP at their peak last summer. Today they’re ‘only’ 2% of GDP higher. That’s still comparable to the twin oil crises suffered by the US in the 1970s, but much better than feared. Moreover, the threat of physical shortages of energy during the winter didn’t materialise thanks to efficiency savings, mild weather and liquified natural gas supplies. 


Phew. A sigh of relief can be heard from economists and investors. Not only has a Bloomberg survey of European recession probability fallen from 80% to 55%, but consensus forecasters also see a robust above-trend recovery starting in the second half of this year. We think this underestimates the pain from the monetary tightening. 


We believe energy shocks have more than one negative effect. First, the direct hit to cashflow from higher energy prices (a negative supply shock). Second, the impact of tighter monetary policy to squeeze inflation out of the system (a negative demand shock). The European labour market is tight, with elevated recruitment difficulties and rising wage growth. The European Central Bank (ECB) is accelerating its rate hikes and the US Federal Reserve seems unlikely to be finished yet as services inflation remains stubbornly high. 

So, although the energy shock has been less painful than feared, there’s more hurt to come from tighter monetary policy. Consensus is rightly enthused about the improvement in real incomes as energy prices fall. But our consumption and investment models also show a role for interest rates and credit conditions. 

Banks made it harder for businesses and households to borrow money last autumn and bank lending has duly collapsed, consistent with recession. Lower energy prices should make banks more confident about growth and encourage them to lend again. However, this is offset by more aggressive policy tightening and falling property (and therefore collateral) prices. Data suggests the European housing market was already rolling over by last Christmas – before the ECB got aggressive with tightening monetary policy. Lower collateral values and higher financing costs should keep banks cautious. 

James Carrick

Global economist

James is a global economist with a knack for using analogies to explain economic concepts. He is a techno-optimist and an early adopter. He enjoys building models - both of the economy and robot Lego ones with his son. He also likes crunching data and chocolate bars. He joined in 2006 from the number-one ranked economics team at ABN AMRO with prior experience at HM Treasury.

James Carrick