(S&P Global Ratings) -- Under a downside scenario of Russia cutting off gas exports to Europe and mandatory EU rationing, Germany would fall into recession, eurozone growth would weaken, and inflation would stay higher for longer.

Much higher inflation would force the European Central Bank to raise the refinancing rate to 3% by early 2024, despite much weaker growth. That's according to S&P Global Ratings' report titled, "Europe Braces For A Bleak Winter." The article posits a downside scenario to its baseline economic forecast published at the end of June. Since then, gas prices have increased further, and the inflation outlook has deteriorated. The next baseline forecast is due out in late September. EU countries are in a race against time to reduce gas consumption by 15% to protect households and businesses from power cuts and rationing this winter. Germany and Italy are most exposed given their heavy reliance on Russian gas. Country by country, three factors are driving economic impact:

  • How much the economy and especially industry depends on natural gas, directly or indirectly;
  • The size of the share of Russian gas in total gas use, and
  • How much governments are prepared to shield households and businesses from higher wholesale energy costs.

In Germany, the blow to consumer spending is much more pronounced because of comparatively higher inflation, driven up by the special levy being introduced in October on top of already much higher retail gas prices.

The impact to France's economy is much weaker because industry uses significantly more power from nuclear energy. Also, the French government has capped the increase in regulated household tariffs through at least 2022.

A key reason why Italy suffers less than Germany is that the country does not have a government-sponsored extra pass-through of wholesale to retail prices. Were other European economies to implement measures similar to those in Germany, scenario results would turn out worse for these economies and the eurozone as a whole. Significantly higher inflation across the eurozone will make it more likely that higher inflation becomes embedded in the domestic economies. In an attempt to curb this effect, if not prevent it altogether, the ECB would raise the refinancing rate above our baseline by an average of 70 basis points in 2023 and a further 40 basis points in 2024, taking it above 3% in early 2024, according to our simulations.

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