In 2022, consumers around the world experienced the shock of the worst inflation in decades. Several factors contributed to the situation, from the extraordinary policy accommodation during the darkest days of the global COVID-19 pandemic, to the lingering effects of lockdowns and pandemic-related disruptions on global supply chains and the labor market. In the case of Europe, the Russian invasion of Ukraine in February created an additional shock, which further boosted energy prices—and in particular the cost of natural gas, on which Europe is particularly reliant. As of October, consumer prices were up 11 percent year-over-year in the United Kingdom, 10.4 percent in Germany, and 10.6 percent in the Eurozone.
As we look into 2023, the picture is mixed. On the one hand, global developments should contribute to a retrenchment in consumer prices; on the other, European consumers aren’t likely to benefit from it until the second half of the year. Under these conditions, it is difficult to see how consumer spending will recover, although forecasts point to a possible rebound by year-end. The trade-offs and behavioral shifts that became apparent in 2022 will continue in the new year. For instance, as gasoline prices quickly rose during the spring, it became apparent that there was little room to cut back on items such as gasoline, transportation, heating, and utility bills in general. Consumers took a wait-and-see approach in an effort to accommodate higher energy prices without cutting back on other expenses.
The resilience in retail sales, though, masked some important adjustments that were happening in consumption baskets, where higher energy prices squeezed both discretionary and non-discretionary day-to-day spending. This was especially obvious in Visa’s U.K. Spending Momentum Index, which as early as February 2022 revealed the size of the shift towards gasoline spending to the detriment of almost all other items. The size and frequency of purchases is another interesting development. Under current economic conditions, we would expect consumers to purchase in bulk as a hedge against rising prices. However, the opposite seems to be the case. Evidence in Europe suggests that families are parceling out their shopping, making more frequent but smaller retail transactions. This probably reflects a journey of adjustment to inflation: behavior that is consistent with a more guarded consumer who is keen on gaining better control over their cash flow and more tightly manage their family budget.
Conscious budgeting and debt avoidance will be paramount, making it unlikely that consumption will regain full steam as inflationary pressures recede. It may take some time for consumers to rebuild their confidence, considering the large shock to real disposable income inflicted by double-digit inflation at 11 percent. As the consumer remains guarded, discretionary baskets will suffer the most, while non-discretionary, day-to-day spend will account for a larger share of total spend.
On the upside, household savings first accumulated during the pandemic remain elevated, with record high levels of retail bank deposits in the European banking system. Inflation has dented their purchasing power, though, and while dissaving may help families to navigate the challenges of the coming months, they won’t avoid the pain altogether. Going forward, it is likely that the consumer will maintain some of the same attitudes adopted during these “cost-of-living” crisis months.
Travel might provide a glimmer of hope, though, for household spending. Travel stayed rather robust through the summer in what came to be know as “revenge travel,” prompted by two years of reduced mobility. This provided an important boost to the economies of countries such as Greece, Turkey, and Italy, which rely heavily on summer tourism. Whether the more favorable conditions of 2022 will persist into summer 2023 is still unclear at this point.
While 2023 is shaping up to be another difficult year for the global economy—and perhaps Europe especially—the fallout from the current high-inflation environment, combined with a more penny-pinching consumer, high savings and tight labor markets, should all contribute to a shallow and relatively short recession looming on the horizon.