Energy crisis poses threat to Europe’s industrial sector

Europe is facing a difficult and uncertain economic outlook.  Governments, households, and firms are grappling with an energy and cost-of-living crisis that was exacerbated by the war in Ukraine. Amid high inflation and rapidly tightening monetary policy, many European countries are expected to suffer a recession over the winter.

The economic downturn may, however, be less severe than suggested by recent forecasts. In the past few weeks, there has been a string of good news on the energy front for Europe. Natural gas prices in Europe have receded sharply over the past three months after hitting an all-time high in August. With Russian pipeline supplies falling steeply, Europe managed to rapidly scale up its purchases from other suppliers. Gas storages are almost completely filled and demand for gas has declined. Efforts by private households, businesses, and government entities to reduce gas consumption have been helped by unusually mild temperatures in autumn.

These trends have fuelled hopes that Europe may be able to avoid the worst-case scenario of massive gas shortages, rationing, and industrial shutdowns in the coming months. Nonetheless, such positive short-term developments should not obscure the challenges Europe’s energy-dependent industries are facing due to high gas and electricity prices, which will likely remain elevated for some time. Industries with gas-intensive production or with high absolute demand for gas could still see disruptions this winter.

Moreover, persistently high prices could create lasting damage, eroding Europe’s competitiveness in high-energy manufacturing activities, causing losses in market share, and prompting companies to relocate to countries with lower energy costs. Germany, which combines a large manufacturing sector with high energy use in industrial production, appears particularly vulnerable to the fallout from the energy crisis. While fears of deindustrialization may be overblown, Europe’s policymakers face difficult trade-offs as they adjust to new geopolitical and energy market realities.

Learn more from the December Monthly Briefing on the World Economic Situation and Prospects.