The coming rapid slowdown in inflation will be the break that will boost the economic cycle in Europe.
I emphasized this point last week. This new dynamic is due to the change in the energy price regime. Excessive in 2022 and comparable to a brutal shock, the lasting rise in the price of gas and electricity had generated a persistent rise in inflation and its spread to the rest of the economy.
Inflation falling over time
Now the price of gas is back to pre-Covid levels. Uncertainty about energy supplies has been greatly reduced. Therefore, the energy contracts that will be signed by the companies will be at much lower prices than last year. For sectors other than energy, including food, the impact of this lower energy price will be seen in higher margins. We can expect more price competition. As inflation slows, wage dynamics will also shift as wages adjust to past price developments.
A positive shock to activity
The major consequence of this rupture is a rapid improvement in the terms of trade for the countries of the euro zone. Imports are already much cheaper. We can already see this in the spectacular reduction in the energy bill. The energy shock had cost 2 to 3 points of GDP in 2022, this additional cost will not be spent in 2023 and will come back into the hands of Europeans.
Domestic demand, which had been penalized by the rise in import prices, will follow a more robust pace. The bill paid in the USA or Qatar will frankly be reduced and the amount will land in the pockets of households and businesses.
The fall in energy prices and its consequences on inflation will boost demand and promote the cyclical recovery in the euro zone. Production and employment will greatly benefit from this new situation. Of course there are higher interest rates at the ECB, of course China is no longer the engine of global growth that it used to be. Nevertheless, this change of regime will create a beneficial momentum for the euro zone.
This strangely resembles the mechanism observed in the mid-1980s which had caused a very favorable period that the crash of October 1987 had not shaken.
A remark is nevertheless in order. The current episode is more virtuous than then. The energy backlash reflected a change in strategy by Saudi Arabia, which had flooded the market with its oil.
This time, there are two explanations for this backlash.
- The risk associated with the energy shock could be diversified. The panel of available energies is much wider than at the time. It changes day-to-day choices.
- The other major point is that the excess energy reflects the acceleration in the availability of renewable energies. On the electricity market it is spectacular. But also more broadly, investments in solar will be higher than those in oil in 2023 according to estimates by the International Energy Agency. The world changes.
Europe will come out stronger, it must take advantage of this particular dynamic to set itself on a virtuous and more autonomous trajectory.