Europe’s economy is slowing as the Ukraine war drives up costs

Economic recovery in Europe slowed in the first weeks of March following Russia’s invasion of Ukraine, while US business activity picked up, business surveys showed.

The effects of the war quickly spread across Europe, disrupting already strained supply chains, weakening confidence and sending commodity and energy prices soaring. The lifting of pandemic restrictions on Europe’s services sector is softening the blow for now. However, economists expect this positive effect to wear off and that the war will weigh more on growth as higher energy costs push up consumer prices.

The United Nations Conference on Trade and Development on Thursday lowered its forecasts for economic growth this year in response to the invasion. It now expects the global economy to grow by 2.6% after previously expecting growth of 3.6%. Much of the slowdown will take place in the euro zone, where Unctad now expects growth of just 1.7%, half of what it previously expected. On the other hand, it lowered its forecast for US growth from 3% to 2.4%.

Data firm S&P Global said on Thursday that its euro-zone composite purchasing managers’ index – a measure of activity in manufacturing and services – fell to 54.5 in March from 55.5 in February. That was a smaller drop than forecast by economists polled by the Wall Street Journal last week. A value above 50.0 indicates an increase in activity.

US firms separately reported an uptick in activity in March, buoyed by a rebound in demand as case numbers from the Omicron variant of Covid-19 declined. An improvement in supply shortages and hiring allowed companies to ramp up production, although they also indicated that the war in Ukraine and China’s lockdowns are increasingly straining supply chains, according to the S&P Global survey.

The U.S. services PMI rose to an eight-month high of 58.9 in March from 56.5 in February. Manufacturers reported a rebound in March, with the PMI coming in at 58.5, the highest in six months, up from 57.3 in February.

Many European countries rely heavily on Russia for energy supplies, including oil and natural gas, which is transported through pipelines. Energy prices had risen in the months leading up to Russia’s invasion of its neighbor on February 24 and have continued to rise since amid fears of a disruption in supplies in the coming months.

As a result, euro-zone firms reported the sharpest increase in costs since records began in 1998. The sub-index that measures costs rose to 81.6 in March from 74.8 in February, well above the previous record high of 76 .0 in November 2021 In response, companies increased their own prices.

“The war has exacerbated existing pandemic-related pricing pressures, which will inevitably translate into higher consumer prices in the coming months,” said Chris Williamson, chief operating officer at S&P Global.

The invasion also dealt a blow to euro-zone consumer confidence, according to a survey released by the European Commission on Wednesday. The monthly survey recorded weaker sentiment in early March, comparable to that seen in early 2020 at the start of the pandemic.

According to S&P Global, European automakers were among the hardest-hit companies in the first few weeks of the invasion. The conflict created shortages of some parts made in Ukraine, leading to the cessation of production at some factories across Europe. However, these supply blockades appear to be easing.

Volkswagen has experienced an easing of the component shortage.


Photo:

Krisztian Bocsi/Bloomberg News

“Due to the short-term improvement in the supply situation for components, Volkswagen Sachsen can ramp up production at the Zwickau and Dresden plants faster than planned in the coming week,” said a Volkswagen spokesman Inc

, the German car manufacturer. The Zwickau site is the company’s most important electric vehicle plant in Europe.

The European Central Bank has already lowered its forecast for euro-zone economic growth this year to 3.7% from 4.2%, on the assumption that disruptions to energy supplies and confidence prove temporary and global supply chains non-essential be affected.

The bank said the damage caused by the Russian invasion could be greater. Cuts in Russian natural gas supplies could cause growth to slow to 2.5% to 2.3%, it said.

Earlier this month, the central bank said it would scale back its government bond purchases over the next three months, potentially ending them entirely by September to stem a rise in annual inflation, which stood at 5.9% in February. Policymakers have stressed that they will be flexible in responding to economic developments over the coming months, rather than sticking to a set path.

The consequences of the tough economic sanctions against Russia are already being felt around the world. WSJ’s Greg Ip joins other experts in explaining the significance of what has happened so far and how the conflict could transform the global economy. Photo illustration: Alexander Hotz

“The current extraordinary level of uncertainty means we must be modest about how accurately we can predict the future state of the economy,” Frank Elderson, an ECB rate setter, said in a speech on Thursday.

The ECB said it could raise interest rates “some time” after the end of bond buying, while the Federal Reserve has signaled it is likely to raise interest rates six more times before the end of this year.

However, Unctad warned that tightening monetary policy in rich countries too quickly could result in an even sharper slowdown in global growth than it forecast and threaten the ability of some developing countries to service their debts. The Geneva-based organization said there was little evidence inflation was driving wages sharply higher, saying higher borrowing costs would not solve the supply chain problems that were partly to blame for soaring prices.

“We’re not convinced it’s going to work,” said Richard Kozul-Wright, director of Unctad’s globalization department. “You can’t solve these problems by raising interest rates.”

In the US, service and manufacturing companies reported broad-based inflationary pressures. US services continued to raise prices as companies passed the higher costs on to customers. Purchasing activity at factories rose at the fastest pace since September 2021 as companies struggled to avoid future price hikes by locking down materials. However, the index showed a slight slowdown in the increase in manufacturers’ selling prices.

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The European Central Bank has lowered its forecast for economic growth in the euro zone this year.


Photo:

Martin Meissner/Associated Press

Confidence in the outlook for next year’s manufacturing slipped to a five-month low in March, mainly due to service providers’ concerns about a slowdown in spending as inflation weighs on consumer incomes. A separate report from the US Department of Commerce on Thursday said orders for durable goods such as appliances, computers and cars fell 2.2% mom in February.

write to Paul Hannon at paul.hannon@wsj.com

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