Prolonged geopolitical uncertainty, coupled with the need to change Europe’s energy mix will keep energy prices higher for longer, posing a major terms-of-trade shock to European economies, says Moody’s.
This holds especially relative to low-energy-cost competitors like the US. “This disadvantage could weaken the region’s long-term price competitiveness and lead to a structural decline in the European Union’s industrial bases over the medium term in the absence of effective government support,” the credit rating agency says in a report sent to Kallanish.
Energy prices have pushed inflation to double-digit levels not seen since the 1980s, which resulted in central banks increasing their policy rates and ending the lengthy period of low interest rates. They also led to a collapse in consumer and business confidence that is choking the post-pandemic recovery. “Higher prices will likely push the industrial sector and the EU economy into a recession over the winter half of 2022-23. These conditions also materially increase the risk of a stagflation scenario taking hold,” Moody’s observes.
Because the EU is a net importer of energy, the surge in prices also presents a longer-term, negative terms-of-trade shock for the region. The EU’s average terms of trade – defined as the ratio between the index of export prices and that of import prices – worsened 4.5% in the first half of 2022, and increased the region’s energy import bill by around 1.5% of GDP, Moody’s says. US terms of trade actually improved 3% because of significant price and volume rise of LNG exports to Europe.
In case of a longer-lasting, continued deterioration of the terms of trade, there is also a high risk of investment in energy-intensive manufacturing sectors shifting away from the EU countries to other countries with lower energy costs like the US, the agency explains.
“Sufficient energy storage and falls in consumption should allow most [EU] sovereigns to avoid government-imposed rationing of energy this winter. However, risks will remain elevated until governments are able to source reliable, long-term alternatives to Russian supplies, which we expect will take years,” Moody’s concludes.
Adam Smith Poland