Europe’s economy performed surprisingly well in summer and fall 2021 and is, as expected  experiencing the typical seasonal economic slowdown this winter. Whether growth picks up again depends largely on developments in the corona virus pandemic. The emergence of new virus variants poses the risk that existing vaccines may be less effective against these mutations. This uncertainty weighs on the expectations of consumers, investors and employees – and weakens economic growth. The interplay of all risks could result in an economic downturn.

Global economic environment: status quo

The outbreak of the corona pandemic in spring 2020 plunged the global economy into a deep recession. However, an economic recovery began as early as the summer of 2020. Economies weakened somewhat in the winter of 2020/21, but then picked up again – especially in the U. S., where extensive economic stimulus programs are driving economic growth.

The extrapolation of quarterly figures to annual real gross domestic product (GDP) show: In the second quarter of 2021, the U.S. had already exceeded the GDP level it had before the outbreak of the corona pandemic. The EU-27 reached its pre-crisis level in the third quarter. Japan and the United Kingdom, on the other hand, are still below their pre-crisis levels.

graph Real GDP of countries

Since late summer or fall 2021, the economic recovery has stalled again. The main reasons for this are high energy prices and disruptions to global supply chains.

Global economic environment: Outlook

Let’s look at the EU Commission’s November 2021 economic outlook for the world’s largest economies:

  • In the U.S., government stimulus programs are still boosting growth. Real GDP is therefore also expected to grow strongly by 4.5 percent in 2022.
  • China’s economy has been growing since the second quarter of 2020. At just over 5 percent, economic growth expected for 2022 is even higher than in the U.S. – but it is weaker than in the phase before the Corona crisis.
  • The United Kingdom is still struggling with the – predictable and predicted – negative consequences of Brexit. It is true that the UK economy is also forecast to grow by about 5 percent in 2022. However, the GDP slump in 2020 of almost 10 percent was much more severe than in the rest of Europe, the U.S. or even Japan.
  • Japan has been struggling with low growth rates since the 1990s. At around 2 percent, the GDP growth expected for 2022 is lower than in the other developed economies.

chart: change of real GDP inside the EU

All in all, the global economic environment is expected to be favorable for the EU in 2022 – at least according to the forecasts published in November 2021. Growth in the rest of the world will primarily benefit the EU’s exporting companies, but also the companies that supply them with intermediate inputs.

Economic situation in the EU

For the EU and the eurozone, the EU Commission forecasts an increase in real GDP of 4.3 percent in 2022, down from 5 percent in 2021. In its forecast for the eurozone published at the beginning of December 2021, the OECD also expects real GDP to increase by 4.3 percent in 2022.

Regional differences can be observed. The general rule is:

  • Countries with a particularly strong upturn in 2021 – e.g. France, Italy and Hungary – must expect somewhat weaker growth in 2022.
  • In Germany, the economic recovery in 2021 was weaker due to the supply bottlenecks mentioned above. GDP growth is expected to be significantly higher in 2022.chart: change of real GDP inside the EU


However, these forecasts are subject to considerable uncertainty. As a result, growth forecasts can deteriorate rapidly. Here is just one example: While the EU Commission expects economic growth of 4.6 percent for Germany in its November 2021 forecast, the December forecasts of two German economic research institutes are less optimistic: the Munich-based ifo Institute expects economic growth of just 3.7 percent in 2022, the Hamburg Institute of International Economics only 3.5 percent.

5 risks to the current economic recovery

For the coming months, I see five main risks to the economic recovery in Europe, which vary in severity.

#1 Inflation risks remain with us

In the fall of 2021, the euro zone experienced inflation rates of up to 5 percent. However, as we have shown, with regard to Europe this is mainly a temporary phenomenon that should weaken in the course of 2022 – if there are no further supply bottlenecks from spring 2022.

However, one driver of inflation is rising energy prices. This trend will continue, because decarbonization of the economy needs carbon prices. If Europe wants to reduce its greenhouse gas emissions noticeably and quickly, rising energy prices are unavoidable – and this has an inflationary effect.

And: Inflationary pressure is larger in the U.S. than in Europe due to strong economic growth. For this reason, the U.S. Federal Reserve will adopt a stricter monetary policy in 2022. The resulting rise in interest rates will weaken the American economic recovery. The growth forecasts for the U.S. mentioned above could then prove to be too optimistic.

#2 Supply chain bottlenecks could ease

Supply chain problems, which are currently causing supply shortages and so slowing economic recovery, should also ease in the course of 2022.

However, this is not guaranteed. If the number of people infected with corona worldwide rises sharply again – as is now the case with the Omicron variant – there is a risk of renewed supply bottlenecks.

#3 Debt problems become more severe as U.S. interest rates turn around

During the corona pandemic, numerous economic players took out loans and so increased their debt levels. This affects both sovereigns and corporations. If a larger number of borrowers are no longer able to finance their interest payments and repayments, there is a risk of payment defaults.

For the lenders – i.e. mainly banks – this means asset losses. That may lead to a crisis for the entire financial system and become the trigger for an economic downturn.

So far, the central banks are still providing the economy with plenty of credit at low interest rates. In view of the still tense economic situation in Europe, I do not expect the European Central Bank (ECB) to raise key interest rates in 2022. The reason for this assumption is the high level of uncertainty about the economic recovery in Europe. Higher interest rates can dampen investment and thus weaken economic recovery. In addition, highly indebted EU member states come under pressure when interest rates rise because their interest expenses then increase. I guess that the ECB does not want to take this risk yet in 2022.

In the U.S., however, as already mentioned, an increase in the key interest rate is to be expected sooner. This raises the credit costs of many companies and also of entire countries.

#4 Geoeconomic conflicts can strengthen protectionism

With the change of administration in the U.S., trade disputes between the U.S. and China and between the U.S. and Europe have eased. However, this does not mean the end of all trade disputes.

This applies above all to the relationship between the U.S. and China, which is not just about trade disputes, but about global technology leadership. In general, it is to be feared that the major economies – again led by the U.S. and China – will increasingly use trade policy instruments in the future to achieve (foreign) policy goals.

The arsenal of measures extends beyond tariffs and non-tariff barriers to include sanctions, export restrictions and export bans. This resurgence of protectionism would disrupt global economic development and weaken economic growth.

#5 Virus mutations as a major uncertainty factor

In my view, the greatest economic risk at present is a sharp rise in the number of infections as a result of new mutations of the coronavirus. If severe restrictions on public life are required in response in Europe again, this will slow down the economic recovery.

Outlook 2022

Even if some of the risks should be manageable, the interplay of all risks could result in an economic downturn. If, for example, there were to be renewed area-wide lockdowns in individual regions of Europe due to rising infection figures, this would lead to production declines and renewed disruptions in supply chains. Supply-side shortages would rise, and with them inflation rates. If the ECB were to raise its key interest rate to combat inflation, this would cause a general rise in interest rates.

Rising interest rates have far-reaching economic consequences: Investments will be reduced, and it will become more difficult to take out new loans to repay old ones. Individual companies and also governments could run into refinancing problems. As outlined above, this could trigger a financial market crisis, which would also plunge the real economy into a crisis.

So the fact remains: Without an effective strategy to fight the corona pandemic on a global level, there will be no stable economic development – either in Europe nor in the rest of the world.