Fitch Solutions Europe Key Themes For 2022: Energy Poverty Could Lead To Political Instability

Fitch Solutions / Country Risk / Europe / Fri 03 Dec, 2021

fs disclaimer
Theme Thoughts
Above-Trend Growth In Eurozone, But Increased Headwinds In Emerging Europe Eurozone growth will be driven by continued policy support as well as an expected easing in consumer price inflation. Growth in emerging Europe, however, could face headwinds as pandemic risks rise. 
Inflation To Peak In H122, But Risks Tilted To The Upside Price pressures will ease in H222 as base effects reverse and some of the supply chain issues that goods trade is currently facing ease. 
Monetary Policy In Europe To Diverge Monetary policy between the eurozone and Central and Eastern European (CEE) countries will remain divergent given that inflation in the latter region will be sticky on the upside. 
Fiscal Policy Tightening Could Be Gradual Relative To Previous Economic Crises Government spending will be tightened, but severe austerity measures will not be put in place as the EU will allow debt levels to remain elevated for longer. 
Green Transition Could Lead To Further Energy Inequality

Renewed emphasis on climate initiatives could make the energy crisis more acute and cause a backlash against the associated rise in living costs, particularly amongst lower income groups across Europe. 

EU-Russia Tensions Will Remain A Key Driver Of Political Risk Persistent tensions between the EU and Eastern Europe will weigh on policymaking on various fronts, particularly energy. 
Source: Fitch Solutions

Theme 1: Above-Trend  Growth In Eurozone, But Increased Headwinds In Emerging Europe

We at Fitch Solutions remain broadly positive about growth in 2022, especially for the eurozone, where we expect output growth to remain above trend in the medium term (see chart below).

Above-Trend Growth In The Eurozone

Eurozone - Real & Potential GDP, EURbn (2006-2030)

Note: Potential GDP based on HP Trend. f = Fitch Solutions forecast. Source: Eurostat, Fitch Solutions

We believe that growth will be driven by two main factors: (1) export order books for key manufacturing hubs, particularly in Germany (the largest economy in the eurozone), continue growing, which means that manufacturing activity will stay robust in 2022; (2) tourism in Europe should continue to benefit from a general re-opening, with the region still having the lowest restrictions globally (see charts below). Growth in the eurozone will also be supported by generally good financing conditions given our view that the European Central Bank (ECB) will keep its monetary policy stance (which includes maintaining the benchmark deposit rate at -0.50% and the refinance rate at 0.00%) unchanged until at least 2024.

Manufacturing And Tourism To Lift Growth In 2022

Europe – Germany Plant & Manufacturing Orders, % chg y-o-y (LHS) & International Tourist Arrivals, % chg y-o-y Versus Borders Closed, % (RHS)

Source: Bloomberg, UNWTO, Fitch Solutions

Our growth view is contingent on the assumption that the recent worsening in the epidemiological situation in Europe will be short-lived. While some countries in the eurozone have ramped up restrictions (Belgium, Germany and the Netherlands) and only Austria has implemented a nationwide lockdown, we believe that with the rise of the more contagious Omicron variant of Covid-19, tighter restrictions in other markets in Europe are likely. In 2022, however, we expect governments to leverage the vaccine rollout and push for booster shots in order to avoid lockdowns as far as possible. This will also mean that those countries in the wider Europe region that have low vaccination rates, such as country Romania, Bulgaria and Hungary, will face challenges on two accounts. First, their interactions with countries that have higher vaccination rates could become restricted. Second, their healthcare sectors could remain under pressure for longer, meaning that domestic controls may stay in place.

Lower Vaccination Rates Are Resulting In A Higher Death Toll

Selected EU Economies - Adults Fully Vaccinated, % & Deaths Per Million, 14-Day Average

Source: ECDC, Fitch Solutions

We see emerging European countries remaining especially vulnerable to a pandemic-related deceleration in growth. Other headwinds to growth in this region remain, such as high energy prices that are weighing on the manufacturing sector and household spending as they have driven up consumer prices and pushed central banks to embark on rapid monetary policy tightening.

Theme 2: Inflation To Peak In H122, But Risks Tilted To The Upside

We at Fitch Solutions expect that consumer price inflation will remain well above central banks’ targets throughout much of H122 before subsiding over H222 (see chart below). The persistence of elevated price pressures at the beginning of 2022 will largely reflect the impact of a number of global factors, namely supply chain issues linked to the pandemic, spiking energy costs that are in part a function of geopolitical tensions and a surge in food prices

Inflation To Ease Back Toward Target In H222

Europe – Consumer Price Inflation, % chg y-o-y

Note: Fitch Solutions forecast; end-of-period forecast. Source: Bloomberg, Fitch Solutions

Our core view remains that these factors will begin to fade over the course of 2022, under the assumption that:

  • Growth in the price of tradeable goods moderates as the pandemic recedes, consumer spending patterns normalise and firms boost their production capacity so that current demand-supply imbalances are resolved.
  • Energy and food costs move from acting as a tailwind to a headwind to consumer price inflation, given our industry analysts' expectation that the current strong price growth is unlikely to be sustained.

The impact of these price dynamics is likely to be most pronounced in developed market economies, most notably the eurozone, where inflation at present is primarily a supply-side story. By contrast, we see some scope for price pressures to prove stickier to the upside for longer in emerging Europe, where labour markets are tighter and there is greater risk of a wage-price spiral forming as a result.

Considerable Labour Market Slack In Parts Of Developed Europe

Europe – Labour Market Slack, % of labour force

Note: ‘Labour market slack’ defined as percentage of extended labour force (15-74 years old) that is unemployed, available but not actively seeking work, seeking work but not yet available or part-time but underemployed. Source: Eurostat, Fitch Solutions

Considerable uncertainty surrounds our inflation outlook, and risks to our forecasts are tilted to the upside. In the near term, our focus is on the potential for a further spike in energy costs. Gas inventories are low in Europe, and there is a risk that worsening Russo-Western tensions or a particularly cold winter on the continent could see prices rise further. This would have implications for food price inflation, with our Commodities team flagging that an associated rise in fertiliser costs could see food price surge. This would have significant negative implications for emerging Europe, where energy and food make up a larger proportion of the consumption basket than in developed Europe. Finally, there is also scope for supply chain disruptions to persist should the epidemiological situation continue to deteriorate in the early months of 2022.

Theme 3: Monetary Policy In Europe To Diverge

Monetary policy will continue to diverge across Europe’s major central banks. We believe that the ECB will leave its benchmark policy rate unchanged at 0.00% (with the de-facto rate as the -0.50% deposit rate) in 2022. Although inflation in the eurozone will remain above target throughout H122, we maintain that the current pickup in price pressures remains transitory, reflecting global supply chain difficulties and a spike in energy prices. Both these factors should gradually turn disinflationary over H222 as base effects reverse, providing the ECB with little incentive to raise rates while national economies are entering a more mature stage in their post-Covid recovery.

Three Different Rate Trajectories Ahead

Selected Economies – Cumulative Policy Rate Changes Between 2021 & 2022, bps

Source: National central banks, Fitch Solutions

CEE central banks will continue to tighten (see chart above). Although policymakers in Prague, Budapest, Warsaw and Bucharest have raised rates by a cumulative 565 basis points (bps) in 2021, we at Fitch Solutions believe that monetary conditions are not yet tight enough to contain demand-side inflationary pressures. Labour markets are already tightening again, and real wages are surging. In the Czech Republic, which has the lowest unemployment rate among its peers, real wages surged by 8.2% y-o-y in Q221 (see chart below), By contrast, real wages have barely moved in the eurozone in 2021, partly owing to a higher amount of slack in the labour market

CEE Will Continue To Hike To Contain Demand-Side Inflationary Pressures

Selected Economies - Labour Market Slack, % of labour force

Note: ‘Labour market slack’ defined as percentage of extended labour force (15-74 years old) that is unemployed, available but not actively seeking work, seeking work but not yet available or part-time but underemployed. Source: Eurostat, Fitch Solutions

In Russia and Ukraine, we believe that the central banks - Central Bank of the Russian Federation (CBR) and National Bank of Ukraine (NBU) - will be in a position to cut in 2022. Just like central banks in CEE, the CBR and NBU have already hiked in 2021, delivering 325bps and 250bps worth of increases respectively. However, once supply-side inflationary pressures fade in H222, both the CBR and the NBU should be in a position to cut, as we believe that the aggressive tightening in 2021 will suffice to bring headline inflation back to target. In Ukraine, we forecast inflation to fall from an estimated 8.0% y-o-y at the end of 2021 to 5.0% by the end of 2022 (compared with a target of 5.0% ± 1pp), whereas in Russia we project inflation to ease from 7.8% y-o-y to 4.5% (compared with a target of 4.0%).

Theme 4: Fiscal Policy Tightening Could Be Gradual Relative To Previous Economic Crises

Following extensive government spending aimed at mitigating the economic impacts of the pandemic in 2020 and 2021, we expect fiscal support to be wound down only gradually in 2022. Total government revenue contracted by a GDP-weighted average of 3.9% in 2020 across the EU’s 27-member states. While this was less than the 5.0% contraction at the height of the global financial crisis (GFC) in 2009, EU governments have shifted to a significantly more expansionary fiscal stance during the pandemic than in previous crises. Expenditure increased by a weighted average of 9.6% in 2020 - compared with a contraction of 5.0% in 2009 and an expansion of 4.1% in 2010 - leading to an average budget deficit of 7.1% of GDP in 2020 versus 6.2% in 2010 (see chart below).

Pandemic Is Weighing On Fiscal Balances More Than GFC

EU-27 - Fiscal Balances Of States During Covid-19 Pandemic (RHS]) & Global Financial Crisis (LHS), GDP-Weighted Average

Note: Averages are weighted according to 2020 nominal GDP. f = Fitch Solutions forecast. Source: National sources, Fitch Solutions

As economies gradually recover, we expect improved revenue generation (up by a projected weighted average of 5.5% in 2021 and 5.2% in 2022) to drive an improvement in government fiscal metrics across the region. However, with support having still been provided in 2021 and only a gradual winding down expected in 2022 (we forecast average expenditure growth of 4.9% in 2021 and -0.2% in 2022), government spending will remain significantly higher than pre-pandemic levels. This will contrast substantially with the restrained spending seen following the GFC as governments adopted austerity measures. We, therefore, forecast the weighted average budget deficit to narrow from 7.1% in 2020 to 6.6% in 2021 and 3.9% in 2022 (compared with 0.5% in 2019). On an individual basis, we forecast that 15 out of 27 member states will have deficits exceeding the 3.0% limit outlined in the Stability and Growth Pact (SGP) (see chart below). While this will be down from a projected 24 members in 2021, it will continue to mark a deterioration from only two deficits passing the limit in 2019.

Many Budget Balances Will Fall Short Of EU Requirements

EU - Budget Balances, % of GDP

f = Fitch Solutions forecast. Source: National sources, Fitch Solutions

Regarding public debt, the number of EU member states with debt-to-GDP ratios above the SGP’s 60% limit rose from 11 in 2019 to 13 in 2020, and we expect it to rise to 15 in 2021 and remain so in 2022. Revenue shortfalls and the sizeable fiscal support packages during the pandemic have forced governments to increase their borrowing substantially, and we expect debt burdens to remain elevated over the short term.  Looking at the previous crisis, the number of countries with debt exceeding 60% rose from eight prior to the GFC to 15 in 2015-2016. We view this as indicative of how challenging it will be for EU members to reduce their debt burdens over the coming year.

More Debt Burdens Are Exceeding SGP Guidelines

Europe - EU Total Government Debt, % of GDP

f = Fitch Solutions forecast. Source: National sources, Fitch Solutions

The significant worsening of public debt metrics, alongside a weaker outlook for public finances, will see the EU’s fiscal rules come under review. Immediately aligning with the SGP’s deficit and debt limits would require austerity measures that risk destabilising the economic recovery. The European Commission has stated that there is scope for an adjustment of the rules around the 3.0% deficit limit and 60% debt ceiling by late 2022 to accommodate for the pandemic continuing to threaten economic momentum. We expect EU governments to be conscious of public discontent tied to the pandemic and its damage to their respective economies, which will further disincentivise a return to harsh austerity, unlike in the aftermath of the GFC.

Theme 5: Green Transition Could Lead To Further Energy Inequality

We expect to see a renewed emphasis on climate policy implementation in 2022 on the back of the COP26 summit in 2021 and the EU’s green deal. However, we think that the political reception of certain policies - such as higher taxes on hydrocarbon fuels - will be mixed, with considerable scope for pushback across the political spectrum. On the one hand, we expect some protestors to argue that the measures implemented by governments across Europe are insufficiently ambitious. On the other, we think that some groups will berate the sudden rise in living costs that could be incurred by changing energy policies.

High Energy Prices Could Spur Backlash Against Costs Of Green Transition

Natural Gas - Spot Price & Future, USD/MMTbu (RHS); UK, France - Electricity Spot Price Indices

Source: Bloomberg, Fitch Solutions

Europe’s energy transition is likely to expose certain inequalities relating to the lifestyles of different demographics, particularly those in rural, lower-income areas where climate scepticism is often higher and car usage is more essential. We see scope for particular tension in areas where hydrocarbon-intensive industries are historically large employers. Energy prices are likely to remain elevated as governments and providers attempt to integrate new technology and energy sources into national energy mixes to meet sustainability objectives. Populist parties across the political spectrum could turn their attention from immigration issues to climate policy-related living costs, arguing for a slower energy transition to defend those groups that are unfairly impacted.

Theme 6: EU-Russia Tensions Will Remain A Key Driver Of Political Risk

In our view, geopolitical tensions in Eastern Europe will persist in 2022 and potentially escalate. The foreign ministry of Germany’s new coalition government will be taken by the Greens, who take a far sterner position on Russia and have consistently opposed the Nord Stream II project. Former chancellor Angela Merkel strove to build bridges with Moscow throughout her tenure, a stance frequently criticised by the Greens and incoming German Foreign Minister Annalena Baerbrook. We believe that the change in leadership in Germany will feed into a tougher EU-wide approach to Russia, to the advantage of Eastern EU countries such as Poland, Lithuania, Latvia and Estonia, which have long been calling for a shift.

Legacy Of Mistrust Persists

Europe - Geopolitical Alignments

Template image: Source: Fitch Solutions

The recent migrant crisis at Belarus’s EU-borders has hardened the resolve of the Baltic states, which if disappointed with the EU’s policy on Russia and Belarus, could turn to the US and NATO for support. The involvement of NATO could see tensions run higher as Russia perceives itself and its sphere of influence to be under greater threat of foreign intervention. Although we maintain our core view that Russia is unlikely to make an incursion into Ukrainian territory in January 2022, as Ukrainian military intelligence claims, we believe that Russia will continue to employee brinksmanship tactics to force more predictable security guarantees with the EU and NATO. Once the Nord Stream II project is officiated, it is likely that pressure from Russia will ease, although we highlight that the project will continue to be a political flashpoint due to the Germany-US July 2021 deal that promises sanctions on the pipeline if it used as a political tool.


This report from Fitch Solutions Country Risk & Industry Research is a product of Fitch Solutions Group Ltd, UK Company registration number 08789939 ('FSG'). FSG is an affiliate of Fitch Ratings Inc. ('Fitch Ratings'). FSG is solely responsible for the content of this report, without any input from Fitch Ratings. Copyright © 2021 Fitch Solutions Group Limited. © Fitch Solutions Group Limited All rights reserved. 30 North Colonnade, London E14 5GN, UK.

Download Indicator Summary

Thank you. Your download link will be emailed to you shortly.

Please complete to access all articles on


Thank you for registering. To read the article please click on the link we have sent to your email address.

Download Now

Thank you. Your download link will be emailed to you shortly.