Russia's war to keep hitting EU economy, push up inflation

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The Euro sculpture stands in front of the former European Central Bank in Frankfurt, Germany, Wednesday, July 13, 2022. The euro on Tuesday fell to parity with the dollar for the first time in nearly 20 years. (AP Photo/Michael Probst)

BRUSSELSRussia's war in Ukraine is expected to wreak havoc with the European Union's economic recovery for the foreseeable future with lower annual growth and record-high inflation, the bloc's economic forecast showed Thursday.

The summer figures for the 19 nations using the euro have set inflation to reach an average of 7.6% this year, a major increase from its May expectation of 6.1%. Last month, consumer prices surged 8.6% from a year earlier.

Expectations for economic growth slid by 0.1 point to 2.6% for the year, a big drop from last year's expansion of 5.3%. Next year, though, when the impact of the war will fully hit the economy, growth is set to slump to 1.4%, far down from the May estimate of 2.3%.

“Russia’s war against Ukraine continues to cast a long shadow over Europe and our economy," EU Vice President Valdis Dombrovskis said.

The war has led to surging energy and food prices that are driving a galloping inflation rate and weighing on economic growth and consumer confidence.

Fears are rising that Europe's energy crisis could get worse and even lead to a recession if Russia further reduces natural gas supplies or turns off the taps completely as European countries scramble to refill their reserves in preparation for winter.

The EU acknowledged that Russian President Vladimir Putin can keep the European economy off balance for months to come and make any forecast highly uncertain.

“The risks are essentially linked to the evolution of the war. Further reductions in gas supply to the EU would send its prices higher and amplify stagflationary forces,” Economy Commissioner Paolo Gentiloni said.

Europe's slumping economic prospects — and a strengthening U.S. dollar — are behind another tough sign: the euro hovering near parity with the dollar after dropping to its lowest level against the American currency in 20 years.

Gentiloni said, however, that the euro was still performing strongly against other major currencies like the British pound and the Japanese yen.

“You can see that the problem is not the weakness of the euro, which is stronger than before against the pound or the yen. But you can see that there is an appreciation of the dollar,” Gentiloni said. “The euro is showing its strength, but the dollar is strengthening more.”

With most of the risks already having materialized, a recent surge in COVID-19 cases is causing new jitters.

“The possibility that the resurgence of the pandemic in the EU would bring renewed disruptions to the economy cannot be excluded,” Gentiloni said.

Overall, he added that “with the course of the war and the reliability of gas supplies unknown, this forecast is subject to high uncertainty and downside risks.” The volatility could also tilt the other way, with a possibility that commodity and energy prices could decline at a faster pace than is now foreshadowed.

After the dark forecast for this year, eurozone inflation is set to rise 4% in 2023, still a huge increase over the spring forecast of 2.7%.

All this stands in sharp contrast from a year ago, when the EU was bouncing back from the pandemic and was ready for prosperous times again.

The eurozone nations also will have to contend with higher borrowing costs, with the European Central Bank set to raise interest rates next week for the first time in 11 years to counter runaway price increases.

Inflation is driven by energy woes in the EU, which for years relied heavily on Russian oil, natural gas and coal to help power cars, factories, heating systems and electricity plants.

And even if the EU has imposed sanctions and plans to phase out coal and oil from Russia, it still remains dependent on the country's natural gas.

European Commission chief Ursula von der Leyen said last week that the bloc needs to make emergency plans to prepare for a complete cutoff of Russian gas. If it materializes, it could have a major impact on the economy.

Gentiloni said that, with few options available in the short run, "this ‘severe scenario' would bring the EU economy into recession over the second half of this year and further depress economic activity next year. In light of recent events, this risk has become more than just a hypothetical scenario.”