INVESTMENT OUTLOOK FOR 2023 - 8 - Eurozone Europe is facing an energy shock unlike anything the region has seen since the OPEC price increases in the 1970s (see Exhibit 2). Even though gas prices have moderated of late, they are still 10 times higher than the average in 2019. Inflation is in double digits in some countries, consumer sentiment has collapsed, and demand is weakening along with disposable income. Nonetheless, we believe headline inflation has peaked and will return to the ECB’s 2% target in 2024. The response of governments to economic shocks has changed since the pandemic. Instead of counting on automatic stabilisers such as unemployment insurance to tide households through the downturn, governments have resorted to more direct support to mitigate any decline in income (or corporate profits). This strategy was comparatively easy during the pandemic as policy rates and inflation were low and central banks were purchasing government debt. The recent experience of the UK, however, shows the limits of these policies now that inflation is well above target and central banks are looking to reduce the size of their balance sheets. While Germany can afford a EUR 200 billion support package, other countries may not. When Italian government bond yields were above 4% prior to the global financial crisis, the country’s debt was a few percentage points less than its GDP. It is now 40% greater. In 2022, debt-GDP ratios nonetheless improved, but in 2023, they will likely see a deterioration. Governments will need to ensure further expenditure is targeted to avoid a countervailing response to any stimulus from the ECB. The EUR 2 trillion NextGenerationEU recovery plan (the largest EU stimulus package ever) will be key to creating a “greener, more digital and more resilient Europe”. Exhibit 2: Energy shock is on par with OPEC crisis in the 1970s Indexed energy prices relative to month of lowest price, log scale 1600 1600 800 800 400 400 200 200 100 100 50 Natural gas (100=2019 avg) 50 25 Brent oil (100=1973 avg) 25 Brent oil (100=2019 avg) 12.5 12.5 -30 -20 -10 0 10 20 30 40 50 60 70 Monts ro rie lo Data as at 21 Oct. 2022. Sources: Bloomberg, BNP Paribas Asset Management