The eurozone’s big four economies –Germany, France, Italy and Spain – have all had their growth forecasts for 2023 downgraded by the International Monetary Fund, as a combination of the war and higher interest rates put a brake on activity.

In the UK, inflation is above 10% for the first time in 40 years as households struggle with rising energy bills. The Bank of England forecasts inflation will peak above 13% in autumn after a fresh increase in energy costs, while the economy will fall into a lengthy recession. Britain is contending with additional pressures from Brexit, the impact of soaring energy prices, supply chain disruption, shortages of workers.

The pain could go on for some time, because countries must wean themselves off Russian hydrocarbons, and building up renewables as an alternative will take time. In the near term a recession in Europe is expected in Europe in the winter of 2022-23 as a result of energy shortages and sustained elevated inflation. The winter of 2023-24 will also be challenging, and high inflation and sluggish growth is expected until at least 2024.


Europe’s largest economy is in the center of the storm, as the energy crisis, and a breakdown in global trade batter its manufacturing base. Economic growth is likely to turn negative in the coming months. It will need an economic miracle for Germany not to fall into recession. The fact that the entire German economic business model is currently up for renovation will also weigh on growth prospects in the coming years. In response to the energy crisis, Berlin has imposed a gas levy for households, due to come into effect from October and lasting until April 2024, which is designed to spread the higher wholesale cost between households and industry. The government has put in place an energy support package worth more than €30bn, including a €300 lump sum for workers, extra support for those on welfare, cuts to petrol and diesel taxes and discounted bus and train tickets.


France should be better insulated than many other European nations, thanks to its large nuclear energy sector, which accounts for just over 70% of its electricity generation, but it has been struggling with serious faults at ageing reactors. Although in a less parlous position than Germany, the eurozone’s second-biggest economy could still face damaging power cuts this winter. GDP rose in France by 0.5% in the second quarter, lower than in other nations across the continent, with domestic consumption notably weak. The government has put in place an emergency support package worth €20bn, including tax cuts at petrol pumps, while capping an increase in regulated electricity prices at 4%, a policy helped by state ownership of the energy giant EDF.


The Italian economy has performed much more strongly recently than its big eurozone rivals, notching up growth of 1% in the second quarter. But like Germany, Italy is heavily dependent on Russian gas. Financial markets and the European Central Bank are already alive to the risks of investors demanding a higher interest-rate premium for buying Italian bonds. With Italy firmly in mind, the ECB announced a new financial instrument last month designed to prevent higher interest rates from having a disproportionately adverse impact on more vulnerable member states. In early August, Italy approved a new aid package worth about €17bn for consumers and businesses, in one of Draghi’s final acts as leader. A tax cut on petrol and diesel, which had been due to expire this month, has also been extended to 20 September. Since the creation of the single currency almost a quarter of a century ago, Italy has been the weakest performing of the “big four”, with living standards barely higher than at the end of the 1990s. It is benefiting this year from a boost to tourism, which accounted for 13% of its GDP before the pandemic. According to the IMF, Italy is actually going to face a complex policy environment. Italy, of course, will need to be very focused on its fiscal stance. It will need to be very focused on bringing the debt to GDP ratio down, as the previous government has been focusing on as an objective. And given recent developments, that will require a more ambitious fiscal effort in the future. As part of that IMF recommendation is to eliminate low quality public spending, broadening the tax base. And what is very important for Italy, but not only for Italy, but also for other countries in Europe, is to really move forward on structural reforms, because structural reforms will increase productivity. They will increase growth. And they will help on energy security and the energy transition. The Next Generation EU fund is an excellent instrument in terms of helping and supporting countries on that road. The implementation of the Next Generation EU fund is critically important for Italy.


Like every other country in Europe, Spain is affected by the war in Russia but of the big four it has the best chance of avoiding recession, despite soaring inflation. There are a number of reasons for this. Its economy went into the crisis in reasonably good shape and – like Italy – has been given an added boost by the surge in tourism after the pandemic. Tourism accounted for 12% of Spain’s GDP before Covid and an even bigger share of employment. But Spain is much less reliant on Russian energy than Italy, and is already a big importer of liquefied natural gas from around the world. GDP rose by 1.1% in the second quarter and the IMF expects it to be the fastest growing of the big four next year. The government has put in place €16bn of financial aid and loans to help companies and households with soaring energy costs. Spain was deeply affected by the pandemic and had a deep recession as part of that. They also had a very strong policy response in order to exiting from this recession. The IMF has a forecast growth for 2022 of 4.3%. That also reflects a strong recovery in tourism. And it is now expecting a slowdown in growth of 1.2% for 2023. Spain experienced the largest contraction among major advanced economies in 2020, and that was reflecting the high reliance on contact intensive sectors. And therefore, output is not expected to reach pre-pandemic levels until early 2024. The forecast for 2023 reflects a general weakening of demand, tighter financial conditions, weaker consumer confidence and persistently high inflation. Spain is one of the countries for which the IMF is not forecasting a technical recession over the next year. Some other countries will experience technical recession and some will have outright recession. So Spain will not experience that and Spain's growth will actually be stronger than in other European countries.

IMF's Views 

Russia’s invasion of Ukraine is now taking a growing toll on Europe’s economies. Gas flows from Russia to Europe have dropped by over 80 percent relative to 2021. As a result, energy prices have spiked, and they are unlikely to return to their pre-war levels soon. This terms-of-trade shock has raised firms’ costs and led to a cost-of-living crisis. In response to higher and more persistent inflation, central banks have acted forcefully, and financial conditions have tightened.

Under these forces, the European outlook has darkened, with growth set to drop and inflation to remain elevated:

- GDP growth in advanced Europe is forecast to fall from 3.2 percent in 2022 to 0.6 percent in 2023. In emerging European economies, growth is also projected to decline sharply, from 4.3 percent in 2022 to 1.7 percent in 2023—a downward revision of 1 percentage point. In the conflict countries, output losses will be very large; Ukraine will see its GDP contract by over a third in 2022, while in Russia GDP is projected to be about 10 percent lower by 2023 than pre-war forecasts.

- Inflation should decline steadily next year, but it will stay significantly above central bank objectives. The IMF projects headline inflation at about 6 percent in advanced European economies and 12 percent in emerging economies in 2023.

Risks to growth are on the downside, and risks to inflation are on the upside. For example, a complete shutoff of remaining Russian gas flows to Europe, combined with a cold winter, could result in gas shortages and rationing, giving rise to GDP losses of up to 3 percent in some Central and Eastern European economies, and yet another bout of inflation across the continent.

In the current environment, European policymakers face severe trade-offs and tough policy choices. They need to bring down inflation while helping vulnerable households and viable firms cope with the energy crisis. Policymakers also need to stay nimble and stand ready to adjust policies, depending on incoming news.

Central banks should continue raising policy rates for now, including in the euro area. And a tighter monetary policy stance might be needed in 2023, unless the deterioration in economic activity materially reduces medium-term inflation prospects. As financial conditions tighten, financial stability risks are resurfacing; regulators should closely monitor vulnerabilities, such as, for example, by stress-testing banks’ exposures to weakening household and firm balance sheets.

On fiscal policy, we have two main messages. First, fiscal tightening should proceed in 2023. Why? Because it needs to work with monetary policy in the fight against inflation and governments need to rebuild the fiscal space that has been depleted by the COVID crisis. Second, fiscal policy also needs to continue to address the cost-of-living crisis, but it needs to do so more efficiently.

In many European countries, governments have taken measures to dampen the passthrough of higher energy prices to households and firms to limit their economic and social costs. However, such measures should be temporary and will have to become more targeted to make sure their fiscal costs remain manageable and—this is crucial—to make sure that energy prices encourage lower energy consumption.

A helpful example of a well-targeted measure is to support low and middle-income households through lump-sum rebates on their energy bills. A less efficient alternative is to implement higher tariffs for higher levels of energy consumption, as some countries have done. While such an approach is not fully targeted to the vulnerable, it is still a better option than broad price caps.

For 2022, on average across Europe, the cost of living for households has gone up by over 7 percent due to higher energy prices. IMF analysis suggests that compensating fully the bottom 20 percent of households would cost 0.4 percent of GDP, compensating the lower 40 percent would cost close to 1 percent of GDP. However, the fiscal costs of some of the existing packages, including new measures being announced, are vastly larger than these numbers. So, clearly, there is room to provide support for vulnerable people at lower cost.

Europe’s governments can also be much more efficient in their support of corporates. Energy security is a European problem; it is best addressed jointly, with an eye on ensuring a level playing field across the ‘single market.’

Finally, it remains essential for European policymakers to implement reforms that do not only relieve energy supply constraints, but also ease tensions in labor markets, enhance productivity, and expand economic capacity—including by accelerating implementation of Next Generation EU programs. Down the road, these measures will raise growth and ease inflation pressures. In other words, they will help address the two pressing economic challenges Europe is facing.

The task ahead is immense. But if European policymakers show once again the strength, coordination and solidarity they were able to muster during the pandemic, it can be done.

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