The End of Abundance
Also in EU Weekly — Poland, NGEU, Travel Ban, Scholz, Boone
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Tough Headwinds Ahead for EU Economy
After a summer of record heat and forest fires, fall should not fail to give cold sweats to European decision-makers. President Macron is already preparing the French for the end of abundance, while energy, inflation, and the fate of Italy will dominate the European agenda in the coming months.
ENERGY • EU energy ministers will meet on 9 September for an extraordinary meeting of the Council of the EU, under the Czech Presidency. The situation is exceptional: the price of one-year gas increased by more than 25% in Germany and France on 26 July, exceeding the €1,000 per megawatt-hour mark, while Gazprom further reduced its gas deliveries. Shell's CEO said on 29 August that the energy crisis could last beyond next winter, even if the Commission's storage targets for winter 2023 are on track to be met.
The decline in gas supply is reflected in the decline in electricity supply. On the one hand, 20% of the electricity produced in Europe uses gas as an input. On the other hand, the European electricity market operates under marginal pricing, where the price of electricity follows that of gas. EDF's difficulties in producing nuclear energy, of which 24 reactors are operating out of 56, do not help the market to calm down.
Soaring prices are spurring many Member States to push for a reform of the functioning of the electricity market, which will be on the agenda on 9 September. The Czech Presidency of the Council of the EU pushes for a dissociation between the gas and electricity markets. Other countries such as Italy, Belgium or Spain, are campaigning for a price cap. Traditionally reluctant countries support the idea of reform, such as German Economy Minister Robert Habeck and Austrian Chancellor Karl Nehammer.
On 29 August, Ursula von der Leyen set the stage at the Bled Strategic Forum, saying:
"The soaring electricity prices today highlight the limits of our current electricity market organisation. This organisation was designed for a completely different situation. That is why we are currently working on an emergency response and structural reform of the electricity market."
INFLATION • With inflation at its highest, the euro at its lowest, the threat of recession and recent announcements by the Fed chairman, the ECB is under pressure. Isabelle Schnabel, a member of the ECB's Executive Board, told Jackson Hole that a "sacrifice" – in terms of growth and jobs – greater than in recent crises would be necessary to reduce the rate of inflation. In plain language, the ECB chooses to keep rates high to bring down inflation, at the cost of lower growth and rising unemployment.
The next ECB meeting will take place on 8 September.
The ECB echoed Fed Chairman Jerome Powell's resolute hawkishness, who confirmed to Jackson Hole the need to keep interest rates high, longer than markets had previously anticipated. The major difference between the US and Europe is that the Fed has already raised interest rates significantly, set between 2.25% and 2.50%. This is not the case for the ECB, which in July made its first rate increase of 0.5%, to reach a rate of 0%.
These differences in euro-dollar rates have contributed to the euro's dizzying fall against the greenback, even below parity. The decline in the euro also reflects the greater impact of the war in Ukraine and the energy crisis on the European economy compared to the energy-independent United States. The decline in the euro is, in turn, contributing to inflation in the euro area due to higher import prices, particularly energy. International markets are betting on a further decline in the euro. Short positions on the common currency have reached their highest level since the beginning of the Covid-19 pandemic in March 2020.
The rise in rates is a substantially more complicated exercise in Europe than in the United States, due to the divergent economic fortunes of the various members of the eurozone. The ECB applies a single interest rate to countries with divergent levels of debt and growth prospects, which could go so far as to cause crises for some, such as Italy, and benefit others, such as Germany or the Netherlands.
To avert a catastrophe in the most indebted countries, the ECB unveiled a Transmission Protection Instrument (TPI) on 21 July. The IPT allows the ECB to intervene in a targeted manner in bond markets in the event of a significant and sudden deterioration in borrowing conditions, measured by the spread between the borrowing rate of the country concerned and that of Germany – a country considered "safe" by bond investors.
ITALY • Markets took short positions against the euro. Italy, in particular, is targeted. Hedge funds have taken their biggest short position against Italian bonds since the 2008 crisis, with more than €39 billion of Italian bonds bought short according to S&P data.
The holding of general elections on 25th September to decide on the succession of Mario Draghi adds political risk to the fragile economic fundamentals of the peninsula. Its dependence on Russian gas and its level of indebtedness became more problematic with the announced departure of Mario Draghi, whose reformist agenda and credibility in the eyes of the financial community and European circles represented a plus.
Melloni or not, the next government must continue the reformist agenda on which Draghi had committed himself to obtain the financing of the NextGenEU recovery plan, according to Draghi himself since Rimini on 24th August. The parties leading the voting intentions — Forza Italia, Fratelli d'Italia and the League — are not exactly on the same page.
In May 2018, President Sergio Mattarella vetoed the appointment of a eurosceptic budget minister as part of the 5-Star movement/League coalition government chaired by Giuseppe Conte. In October 2018, the European Commission rejected the draft budget for 2019 presented by the Coalition Government of the 5-Star Movement/League chaired by Giuseppe Conte. Markets like the Commission will certainly have a harder tooth if this scenario arises again.
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In Case You Missed It
POLAND • On 28 August, four associations of EU judges – the Association of European Administrative Judges (AEAJ), the European Association of Judges (EAJ), Rechters voor Rechters (Judge for Judges) and European Magistrates for Democracy and Freedoms (MEDEL) – filed a complaint against the Council of the EU before the Court of Justice of the European Union (CJEU). Their legal action concerns a decision taken in June in which the Council approved the Commission's assessment of Poland's National Recovery Plan. This decision allows Poland to access EU funds once "milestones" regarding the independence of the judiciary have been reached. According to the four associations, these "milestones" are not only insufficient, but also not in line with previous ECJ decisions on the subject.
TRAVEL BAN • The Council of the EU will discuss the suspension of visa facilitation agreements with Russia on Wednesday 31 August. While some Member States are calling for an outright EU travel ban, the issue is divisive. Some Member States have unilaterally stopped granting tourist visas to Russians not affected by sanctions, such as the Czech Republic and Poland. Under pressure from President Zelensky, voices were heard calling for a European travel ban, which did not please Josep Borrell, Emmanuel Macron and Olaf Scholz. Paris and Berlin are voicing their opposition to this measure, which is supported by Eastern European countries.
SCHOLZ IN PRAGUE • On 29 August, Olaf Scholz was in Austria to give a speech at the Charles University in Prague. He explained his vision for the future of a EU made of 30 or even 36 Member States. He also spoke in favour of abandoning unanimous voting in the Council for fiscal matters, foreign policy and rule of law procedures. Scholz also spoke out in favour of the European Political Community proposed by President Macron. The speech essentially repeats proposals already made by the German Chancellor this year. For a summary of the key points of this speech, we recommend this thread by Thu Nguyen, from the Centre Jacques Delors in Berlin.
SAN FRANCISCO • The European Commission is going to open an office in San Francisco on 1 September. Gérard de Graaf, previously at DG CNECT – communication networks, content and technology – will head the Commission's Californian office, closer to the Big Tech sector – which will soon see the Digital Markets Act and the Digital Services Act apply. The development of a European digital diplomacy is inspired by the appointment of tech ambassadors by many countries, such as Denmark and Austria – which are keen to send their diplomats as close as possible to the digital giants. Last year, the US and the EU also created the Trade and Technology Council (TTC) to discuss cooperation on trade and technology.
What we’ve been reading this week
Laurence Boone, Secretary of State for European Affairs, writes in the Financial Times to call for Europe to become a global political power. She reviews major issues: defence, industrial sovereignty, democracy and geopolitics.
According to CER’s Charles Grant, Emmanuel Macron is serious about his plan for a European Political Community. While enthusiasm in European capitals has so far been lacking, the EPC could become a serviceable setting for discussions between EU states and their neighbours.
Also at the CER: John Springford reminds us that Europe is far more dependent on globalisation than America is. The path to take, he argues, is not a retreat into mercantilism, but a mix of regulation and stockpiling to ensure the supply of essential goods, and the diversification of trade away from China.
For the Financial Times, Ben Hall profiles Giorgia Meloni and her party, Fratelli d'Italia, currently leading the polls to lead Italy's next governing coalition with Silvio Berlusconi and Matteo Salvini.
This week’s newsletter is brought to you by Maxence de La Rochère and Augustin Bourleaud. See you next Tuesday!