Macro – Europe outlook

Can Europe stand the economic heat of the Russia-Ukraine conflict?

13 June 2022

By Henk Potts, London UK, Market Strategist EMEA

  • This year’s widely-expected economic boom in the eurozone has been stopped in its tracks by the fallout from Russia’s invasion of Ukraine, which has stoked inflation and contributed to softer global growth
  • The European Union is looking to cut its reliance on Russian energy, but taking a moral stand may also be costly – Barclays Investment Bank estimates the move could lead to a 5% drop in GDP growth in the region
  • The Russia-Ukraine war is adding new troubles to Europe’s already stressed supply chains – with China’s COVID lockdowns causing yet another challenge for global logistics
  • There are also gloomy predictions for European manufacturing. Add in the potential hit from any rationed energy supplies and higher interest rates – and there’s a real threat of recession in the bloc

Europe’s economy is being battered by surging inflation, supply bottlenecks, and the economic fallout from the war in Ukraine. As politicians grapple with cutting reliance on Russian fuel while keeping the lights on at home, is an energy shock about to tip the continent into recession?

Hopes of a vigorous European recovery early this year have been ruined by the ramifications of the conflict in Ukraine, impact of renewed COVID-19 restrictions, record high price rises, and supply-chain disruptions. Growth forecasts have been slashed, inflation projections ramped up, and recession risk is rising.

Concerns that Europe’s growth profile could tumble and inhibit the European Central Bank’s ability to normalise policy, pushed the euro to its lowest level against the dollar in five years at the start of the second quarter. 

War in Ukraine  

Russia’s decision to launch a full-scale invasion of the country has been described as the biggest security issue to face Europe since the second world war. The clash has far reaching economic consequences for the region, including the potential rationing of energy, surging price pressures, and additional policy complications.

The starkest risk, from an economic perspective, is through the energy channel. In 2021, Europe imported 155 billion cubic metres of natural gas from Russia1, equating to around 40% of its consumption. The region also imported close to 25% of it petroleum products2.

Fears that Russia will weaponise its energy reserves have been elevated to near crisis levels, after Gazprom announced in April that it would suspend gas flows to Poland and Bulgaria until the two countries paid for the fuel in roubles. The European Union (EU) has refused Moscow’s demands for payments in the Russian currency, stating that it would violate sanctions and help prolong the war.

Balancing morals with energy security  

European leaders will try to manage the difficult balancing act of securing the energy needs of their economies, while also applying pressure on President Vladimir Putin to end the war. European lawmakers have begun to outline plans to introduce a phased embargo on Russian oil over the next six months.

Meanwhile, Putin appreciates his timeframe to apply maximum economic leverage is before Europe can establish alternative sources of fuel. Consequently, either Russia reducing the flow of gas or Europe imposing a full embargo risks a significant energy supply shortfall and much higher commodity prices.

The consequences of either rationing or sanctioning could weaken manufacturing output, household disposable incomes, and corporate profitability levels. Another supply shock would probably add to broader price pressures, thereby further stoking inflation.

Worst-case scenario  

Barclays Investment Bank estimates that under a more extreme scenario, aggressive rationing, soaring energy prices (Dutch gas futures up 200%, oil up around 40%), and hit to confidence levels could throw the eurozone into recession, with gross domestic product (GDP) tanking by around five percentage points.

Covid-19 restrictions

Europe’s battle with COVID-19 has proved to be a protracted one. Renewed restrictions imposed at the end of last year as a result of the Delta and Omicron variants continued into the first quarter (Q1)3, undermining demand, particularly in high-contact sectors.

The supply of labour also worsened as sickness rates soared. Eurozone GDP grew at an anaemic 0.3% quarter-on-quarter rate in Q1, which reflected weaker consumption that was only partially offset by stronger investment and the robust order backlog for manufacturers. On a regional basis, the Italian economy contracted, the French one stagnated, while Germany’s barely avoided a recession.

On a more encouraging note, businesses and households have adapted to the restrictions as the year has progressed, allowing activity levels to pick up. The significant easing in coronavirus rules over the past couple of months has already seen a jump in mobility, according to Google data. This trend is expected to continue through the rest of the year, assuming the medical outlook doesn’t worsen.

Industrial output     

Due to the adverse effects of the war in Ukraine, supply bottlenecks in China, and an expected reduction in investments, the outlook for European manufacturing remains gloomy. Higher fuel prices have seen input costs surge in many sectors, particularly the most energy-intensive ones, including metals, chemicals, and cement. The shortage of semiconductors, and other components, has weighed on the production of computers, electronics, and autos, among others.

As companies overcome logistical constraints and capacity increases, supply chains should slowly improve. The extended lockdowns in China, however, suggest that the unravelling of these hurdles to output will take considerably longer than previously estimated, and continue to weigh on European industrial production. 


Labour markets in Europe have continued to improve with the recovery from the pandemic (see table). In March, Eurozone unemployment hit a record low, with the jobless rate falling to 6.8% compared to 8.2% the same month the previous year4. Tight labour markets and rapid inflation has emboldened powerful union leaders to demand higher wages to offset the increased cost of living. While settlements, so far, have lagged behind price increases, the risk of an inflationary spiral seems to be rising. 

Eurozone economic forecasts, year on year (%)




GDP growth




CPI inflation




Unemployment rate




Gross public debt (% of GDP)




Private consumption




Source: Barclays Research, Barclays Private Bank, May 2022


Eurozone inflation hit a record high of 8.1% year-on- year (y/y) in May5, boosted by a sharp increase in energy component prices, while the preliminary reading for May points to an even greater 8.1% increase. Cost-side pressures have also been driving food inflation. The April reading is unlikely to represent the peak, despite many countries having cut taxes or offered rebates to offset the immediate impact of higher fuel prices.

Given the recent rise in energy futures, ongoing supply disruption from China, and elevated soft commodity prices, we tentatively forecast that Eurozone inflation will peak at 8.5% y/y in September. After the summer, the base effects from the oil price surge from late last year should start to ease annual comparisons.

Stagflation is a term that keeps many-a-central banker awake at night. Despite decelerating growth prospects, policymakers are becoming more vocal about the need to speed up the tightening timetable for interest rates in an effort to curb inflation. Officials have already indicated that net-asset purchases under the asset-purchase programme (APP) will be concluded by the third quarter, which could pave the way for a rate hike in the second half of this year.

Fears of a wage-price spiral and/or a de-anchoring of inflation expectations, has encouraged members of the Governing Council to issue a raft or hawkish commentary of the past couple of weeks, fuelling market expectations that a summer hike is now on the cards.

We now expect the first ECB rate hike (25bp) will occur in July followed by a further quarter-of-one-percent increase in at the September, October, and December meetings. There is also a possibility that the central bank will raise policy rates one more time in the first quarter of next year before pausing, as growth and inflation starts to trend lower. We do, however, remain cognisant that the hiking cycle could be delayed or slowed should economic activity significantly weaken.

Growth prospects     

Europe’s immediate growth prospects are likely to be determined by the flow of energy, level of supply-chain improvement, and the path of monetary policy. We expect that Q2 growth will be relatively flat, before a more meaningful recovery in the second half of the year. However, the very clear and present danger to energy supplies means that our 2.3% growth forecast for this year could rapidly contract, possibly into a recession. That said, economic expansion in the bloc is uneven (see chart).

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