As war drags on, European economy succumbs to crisis

It was meant to be Europe's stellar year. A post-pandemic spending euphoria, supported by copious government spending was set to drive the economy and help fatigued households regain a sense of normality after two dreadful years.

But all that changed on February 24 with Russia's invasion of Ukraine. Normality is gone and crisis has become permanent.

A recession is now almost certain, inflation is nearing double digits and a winter with looming energy shortages is fast approaching.

Though bleak, this outlook is still likely to get worse before any significant improvement well into 2023.

"Crisis is the new normal," says the Alexandre Bompard, the Chief Executive of retailer Carrefour. "What we have been used to in the last decades - low inflation, international trade - it's over," he told investors.

The change is dramatic. A year ago most forecasters predicted 2022 economic growth near 5 per cent. Now a winter recession is becoming the base case.

Households and businesses are both suffering as the fallout of the war - high food and energy prices - is now exacerbated by a devastating drought and low river levels that constrain transport.

At 9 per cent, inflation in the euro area is at levels not seen in a half a century and it is sapping purchasing power with spare cash used up on petrol, natural gas and staple food.

Retail sales are already plunging, months before the heating season starts and shoppers are scaling down their buys. In June, retail sales volumes were down nearly 4 per cent from a year earlier, led by a 9 per cent drop recorded in Germany.

Consumers turn to discount chains and give up high end products, switching to discount brands. They have also started to skip certain purchases.

"Life is becoming more expensive and consumers are reluctant to consume," Robert Gentz, the co-CEO of German retailer Zalando, told reporters.

Businesses have so far coped well thanks to superb pricing power due to persistent supply constraints. But energy intensive sectors are already suffering.

Close to half of Europe's aluminium and zinc smelting capacity is already offline while much of fertilizer production, which relies on natural gas, has been shut.

Tourism has been the rare bright spot with people looking to spend some of accumulated savings and enjoy their first care-free summer since 2019.

But even the travel sector is hamstrung by capacity and labour shortages as workers laid off during the pandemic were reluctant to return.

Key airports, such as Frankfurt and London Heathrow were forced to cap flights simply because they lacked the staff to process passengers. At Amsterdam's Schiphol, waiting times could stretch to four or five hours this summer.

Airlines also could not cope. Germany's Lufthansa had to publish an apology to customers for the chaos, admitting that it was unlikely to ease anytime soon.

That pain is likely to intensify, especially if Russia cuts gas exports further.

"The gas shock today is much greater; it is almost double the shock that we had back in the 70s with oil," Caroline Bain at Capital Economics said. "We've seen a 10 to 11 fold increase in the spot price of natural gas in Europe over the last two years."