Resources | Market Trends | 31 March 2022

What Skyrocketing Inflation Could Mean for Europe in 2022

Across Europe, inflation is rising faster than predicted because of higher energy costs and the Russia-Ukraine war.

rising market line across papers on a desk

Across Europe, inflation is rising faster than economists predicted, in large part because of higher energy costs and spillover effects from the Russia-Ukraine war.

It’s yet another pressing concern for businesses that have endured massive disruption in recent years. What’s the key to handling this new challenge? As C2FO’s COO for EMEA, Mark Thomas has unique insight into how companies across Europe are optimising their supply chains and working capital to meet the moment.

“Resilience and the ability to adapt rapidly to changing circumstances are critical attributes for businesses to succeed in this economic climate,” he said.

When the European Commission predicted what 2022 would look like, officials expected higher inflation might be an issue because of supply chain slowdowns, increased demand and the lingering effect of COVID-19.

As a result, the commission’s winter economic forecast projected that inflation could hit 3.5% year-over-year (YoY) in the first quarter.

Unfortunately, the reality has been worse: Inflation hit 7.5% on a YoY basis in March for the euro zone. In February, it was 6.2% in the United Kingdom.

The Bank of England thinks the situation could deteriorate further. At its meeting in mid-March, the bank forecast that, depending on the war in Ukraine, inflation could reach 10% this year.

Rising prices for oil and gas, due in large part to the war, are key drivers of inflation growth. Russia has supplied about 40% of Europe’s imported natural gas and roughly 25% of its oil imports.

According to Eurostat, inflation in energy costs was 44.7% percent in March on an annual basis. Meanwhile, UK petrol and diesel prices hit new highs in February, at 147.6 pence per litre and 151.7 pence per litre, respectively.

There’s also an impact on food costs. Ukraine is a massive supplier to the EU, delivering nearly half its corn and about a fifth of its soft wheat.

So what does this mean for businesses?

Lower growth forecasts

The economic outlook has dimmed because of the surge in inflation and the war in Ukraine, but several observers still say growth is possible.

Fitch Ratings, for example, is now projecting the eurozone will see 3% GDP growth this year, or 1.5 percentage points less than originally expected. As a point of comparison, Fitch cut its forecast for global GDP growth by 0.7 percentage points, to 3.5%.

In its winter forecast, the European Commission expected the EU’s economy would grow by 4% this year. The European Central Bank (ECB) believes the EU’s real GDP could grow by 3.7% this year, as private consumption recovers.

“The expected improvement beyond the near term is based on a number of supporting factors: a diminishing economic impact from the pandemic, a gradual unwinding of supply bottlenecks and an improvement in export price competitiveness vis-à-vis key trading partners,” the bank reported.

According to the ifo Institute, Germany could see 2.2% to 3.1% growth in GDP this year, less than the 3.7% originally expected, because of the Russian-Ukrainian war and rising commodity prices.

But consumer demand and a brighter COVID-19 outlook might still reduce that impact.

“Manufacturers’ order books are fuller than they have been for decades,” the institute noted. “There should also be a strong boost from the normalisation of private consumption if the coronavirus situation improves in the course of the spring.”

Higher interest rates

In March, the Bank of England raised interest rates by 0.25 percentage points to 0.75%, following hikes in December and February. It’s been decades since the bank has increased rates at three meetings in a row. The bank signalled that it would be open to further “modest” increases, but not as many as the US Federal Reserve, which could execute six hikes in the coming months.

The ECB hasn’t raised rates yet, saying it would first reduce its bond purchases over the next several months. The earliest any interest hike could happen would be sometime in the third quarter.

And if inflation continues to skyrocket?

“It all depends on the data,” ECB Vice President Luis de Guindos said in an interview.

“We are monitoring developments in inflation very closely. We will be extremely vigilant concerning second-round effects, and we will be attentive to any developments that could indicate a wage-price spiral, where both factors become mutually reinforcing.”

What you can do now

Inflation is a real and pressing threat for businesses in 2022. Policymakers are trying to find the right balance. They want to use higher interest rates to push back against inflationary pressures without destroying consumer demand, pushing the economy into recession or stagflation. But the next few months are going to be uncertain.

In a situation like this, liquidity is essential for businesses.

“Flexibility is key, especially when it comes to managing cash flow and working capital as needs and priorities change,” C2FO’s Thomas said.

Having ready access to working capital gives companies the ability to lock in prices for essential materials and inventory, or adapt to sudden price shocks.

“The C2FO platform, which allows our customers to accelerate invoice payments on demand, is a powerful tool in this environment,” Thomas said. “For example, we have many users who are currently accessing liquidity from their Accounts Receivable to invest in higher than usual inventory or materials, before inflation raises prices even further.”

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