Gas price increase in Europe

The price of natural gas in the EU has soared to the highest level ever. The reason is that Gazprom, the Russian state-run gas producer, said that it will cut Nord Stream 1 deliveries from 40% of capacity to 20%. Gazprom says that the cutback in deliveries is due to problems with turbines.

What happens next? If the cutback in supplies from Russia is sustained, and assuming European governments are unable to fully offset the cutback with alternative supplies, it is likely that, in some countries, there will be rationing of gas. This will likely mean limits on industrial use, thereby leading to a sharp decline in manufacturing output. Moreover, the sharp increase in the cost of heating homes will eat into consumer purchasing power. The result will likely be a recession. 

For the ECB, this will create a conundrum. Its policy of tightening monetary policy is meant to address inflation. Yet the lion’s share of inflationary pressure is coming from the rise in energy prices over which the ECB has no control. All it can do is engineer a slowdown or recession by suppressing aggregate demand. Yet if a recession is already coming, the ECB might be reluctant to tighten severely and make it worse. Indeed, the ECB has been far more cautious about tightening than the central banks of the United States, the United Kingdom, and Canada.