Europe's economy is proving more resistant to the latest energy shock than many investors and policymakers had expected, with business activity accelerating even as higher oil and gas prices raise costs for companies and households. The improvement is particularly notable because the euro area is dealing with simultaneous pressures from the conflict in the Middle East, disruptions to energy supplies and continuing uncertainty linked to the war in Ukraine.
Preliminary business surveys show that economic activity across the euro area accelerated sharply in September. The composite purchasing managers index rose to 53.1 from 52.0 in August, marking the strongest expansion in more than three years and exceeding market expectations. Both services and manufacturing contributed to the improvement, while new orders increased at their fastest pace in more than four years.
The figures do not suggest that Europe has escaped the consequences of higher energy prices. Companies are reporting increased input costs and some are passing those costs on to customers. The important development is that demand, employment and business activity have so far remained strong enough to absorb a significant portion of the shock without producing an immediate contraction.
The European Central Bank's latest economic projections also point to greater resilience than previously anticipated. The central bank expects euro area growth of around 0.9 percent in 2026 and 1.2 percent in 2027, while acknowledging that the outlook remains highly uncertain because of energy prices and the continuing Middle East conflict.
Services and Manufacturing Are Providing the First Buffer
One reason the energy shock has not produced a larger immediate downturn is the breadth of the current expansion. The September survey did not show improvement in only one part of the economy. Services activity strengthened significantly, while manufacturing output also remained in expansion territory, creating a broader base for growth.
Services are particularly important because they generally have a different exposure to energy prices than industries such as chemicals, metals, glass and other energy intensive manufacturing sectors. A restaurant, professional services company or software business can still face higher electricity, transport and heating costs, but energy is typically a smaller component of total production costs than it is for heavy industry.
The recovery in services demand is therefore helping offset some of the pressure on energy intensive businesses. France recorded its strongest service sector expansion in more than two years, while Germany also reported solid overall business activity. The improvement in new orders across the euro area suggests that companies are still receiving sufficient demand to maintain production and employment despite the deterioration in their cost environment.
That does not mean manufacturing has become immune to energy prices. European manufacturers remain exposed to electricity, natural gas, fuel and transport costs, while supply disruptions can create additional problems. But the current survey data suggest that industrial activity has not collapsed in response to the shock, providing another reason for the broader economy to remain resilient.
The composition of European growth therefore matters. An economy with expanding services, recovering manufacturing and rising employment can absorb an energy shock more effectively than one dependent on a single energy intensive sector.
Europe's Earlier Energy Adjustments Are Now Paying Off
Europe's response to the previous energy crisis has also changed the starting point for the current shock. Following the severe disruption to energy supplies after Russia's invasion of Ukraine, European countries invested heavily in alternative gas supplies, storage, renewable generation, energy efficiency and infrastructure designed to reduce dependence on Russian energy.
That adjustment does not protect Europe from a new oil or gas shock, but it has reduced some of the vulnerability that was evident several years ago. The European economy now has more diversified energy supply arrangements and substantially greater experience in managing disruptions.
The European Central Bank has acknowledged that the euro area has been more resilient to the current Middle East energy shock than earlier projections suggested. Its September projections state that the impact of the conflict on economic activity has so far remained contained, while confidence and short term growth indicators have improved.
However, the improvement should not be confused with immunity. The same projections estimate that inflation will rise because of higher energy prices, with headline inflation expected to reach 3 percent in 2026 before moderating as the energy shock fades. In a more severe scenario involving a larger and more persistent energy disruption, inflation would remain considerably higher and economic growth would weaken significantly.
The lesson is therefore not that Europe's energy vulnerability has disappeared. Rather, the region has developed greater capacity to absorb an initial shock without immediately passing it through to every part of the economy.
Strong Demand Is Helping Companies Absorb Higher Costs
Another reason for the unexpected resilience is that companies are still experiencing sufficient demand to maintain output and hiring. The latest survey showed new orders across the euro area rising at their fastest rate in more than four years, supported partly by stronger exports.
That matters because energy shocks become more damaging when companies face higher costs at the same time that customers reduce spending. Businesses then have limited ability to pass additional expenses on to buyers and may respond by cutting production, investment or employment.
The current situation is different. Companies are facing higher input prices, but many still have enough demand to transfer part of those costs to customers. The September survey indicated that firms increased employment as they responded to stronger activity, providing an additional source of household income and supporting consumption.
There are limits to this process. If energy prices remain elevated for a prolonged period, companies may eventually find it harder to pass the entire increase through to customers. Households also face higher fuel, transport and utility costs, which can reduce disposable income and weaken consumption.
Recent consumer confidence data already show some deterioration as higher energy prices affect household expectations. This creates a potential weakness beneath the stronger business figures because consumer spending remains an important component of the European economy.
The Energy Shock Is Still a Monetary Policy Problem
The resilience of economic activity creates a difficult problem for the European Central Bank. A weak economy facing higher energy prices would normally create a difficult tradeoff for monetary policymakers, because raising interest rates to control inflation could further weaken demand.
The latest data complicate that calculation. Stronger business activity means the economy appears capable of absorbing some monetary tightening, while rising energy prices are creating renewed inflation pressure. The September projections from the European Central Bank expect inflation to peak at 3.6 percent in the final quarter of 2026 before declining as the energy shock fades.
Markets have consequently increased expectations for additional interest rate increases. But ECB officials have emphasized that monetary policy will not automatically respond to every increase in energy prices. The central bank is assessing whether the shock remains concentrated in energy or begins to spread more broadly through wages, services and other prices.
This distinction is critical. If companies simply absorb some higher energy costs and inflation returns towards target once energy prices stabilize, the shock could remain relatively temporary. If higher energy prices become embedded in wages and service prices, the ECB would face a more persistent inflation problem.
So far, there is evidence that the second round of effects remains limited. Wage pressures have not accelerated to the extent that would indicate a broad inflation spiral, although the risk remains if energy prices stay high for longer.
Germany and France Show Different Forms of Resilience
The performance of Europe's two largest economies also helps explain the broader picture. Germany has faced considerable pressure from weak industrial competitiveness, high energy costs and subdued exports, making its ability to maintain expansion particularly significant. Recent business surveys have nevertheless shown improving manufacturing sentiment, while infrastructure spending and government support are providing additional demand.
France is benefiting more strongly from services, where activity has rebounded despite higher energy costs. The French government has also introduced targeted support measures for households and businesses affected by higher fuel prices, although such measures increase pressure on already strained public finances.
These differences show why the euro area's resilience cannot be attributed to a single factor. Some economies are being supported more by services, others by manufacturing, public investment or exports. The common feature is that the energy shock has not yet overwhelmed the combination of domestic demand, employment and business activity.
That resilience remains conditional. The European Central Bank's own scenarios show that a longer and more severe energy disruption would produce significantly weaker growth and substantially higher inflation.
For now, however, Europe's economic performance suggests that the region has entered the latest energy crisis with stronger defenses than during earlier disruptions. Diversified energy supplies, improved infrastructure, a relatively strong services economy, recovering industrial activity and continued employment growth are helping absorb the initial pressure.
The crucial question for the coming months is not whether Europe can withstand a temporary energy shock, but whether businesses and households can continue absorbing higher costs if the disruption lasts longer. The September data provide evidence of resilience, but they do not remove the underlying risks created by energy prices, inflation and geopolitical uncertainty.
(Source:www.thedailyguardian.com)
Preliminary business surveys show that economic activity across the euro area accelerated sharply in September. The composite purchasing managers index rose to 53.1 from 52.0 in August, marking the strongest expansion in more than three years and exceeding market expectations. Both services and manufacturing contributed to the improvement, while new orders increased at their fastest pace in more than four years.
The figures do not suggest that Europe has escaped the consequences of higher energy prices. Companies are reporting increased input costs and some are passing those costs on to customers. The important development is that demand, employment and business activity have so far remained strong enough to absorb a significant portion of the shock without producing an immediate contraction.
The European Central Bank's latest economic projections also point to greater resilience than previously anticipated. The central bank expects euro area growth of around 0.9 percent in 2026 and 1.2 percent in 2027, while acknowledging that the outlook remains highly uncertain because of energy prices and the continuing Middle East conflict.
Services and Manufacturing Are Providing the First Buffer
One reason the energy shock has not produced a larger immediate downturn is the breadth of the current expansion. The September survey did not show improvement in only one part of the economy. Services activity strengthened significantly, while manufacturing output also remained in expansion territory, creating a broader base for growth.
Services are particularly important because they generally have a different exposure to energy prices than industries such as chemicals, metals, glass and other energy intensive manufacturing sectors. A restaurant, professional services company or software business can still face higher electricity, transport and heating costs, but energy is typically a smaller component of total production costs than it is for heavy industry.
The recovery in services demand is therefore helping offset some of the pressure on energy intensive businesses. France recorded its strongest service sector expansion in more than two years, while Germany also reported solid overall business activity. The improvement in new orders across the euro area suggests that companies are still receiving sufficient demand to maintain production and employment despite the deterioration in their cost environment.
That does not mean manufacturing has become immune to energy prices. European manufacturers remain exposed to electricity, natural gas, fuel and transport costs, while supply disruptions can create additional problems. But the current survey data suggest that industrial activity has not collapsed in response to the shock, providing another reason for the broader economy to remain resilient.
The composition of European growth therefore matters. An economy with expanding services, recovering manufacturing and rising employment can absorb an energy shock more effectively than one dependent on a single energy intensive sector.
Europe's Earlier Energy Adjustments Are Now Paying Off
Europe's response to the previous energy crisis has also changed the starting point for the current shock. Following the severe disruption to energy supplies after Russia's invasion of Ukraine, European countries invested heavily in alternative gas supplies, storage, renewable generation, energy efficiency and infrastructure designed to reduce dependence on Russian energy.
That adjustment does not protect Europe from a new oil or gas shock, but it has reduced some of the vulnerability that was evident several years ago. The European economy now has more diversified energy supply arrangements and substantially greater experience in managing disruptions.
The European Central Bank has acknowledged that the euro area has been more resilient to the current Middle East energy shock than earlier projections suggested. Its September projections state that the impact of the conflict on economic activity has so far remained contained, while confidence and short term growth indicators have improved.
However, the improvement should not be confused with immunity. The same projections estimate that inflation will rise because of higher energy prices, with headline inflation expected to reach 3 percent in 2026 before moderating as the energy shock fades. In a more severe scenario involving a larger and more persistent energy disruption, inflation would remain considerably higher and economic growth would weaken significantly.
The lesson is therefore not that Europe's energy vulnerability has disappeared. Rather, the region has developed greater capacity to absorb an initial shock without immediately passing it through to every part of the economy.
Strong Demand Is Helping Companies Absorb Higher Costs
Another reason for the unexpected resilience is that companies are still experiencing sufficient demand to maintain output and hiring. The latest survey showed new orders across the euro area rising at their fastest rate in more than four years, supported partly by stronger exports.
That matters because energy shocks become more damaging when companies face higher costs at the same time that customers reduce spending. Businesses then have limited ability to pass additional expenses on to buyers and may respond by cutting production, investment or employment.
The current situation is different. Companies are facing higher input prices, but many still have enough demand to transfer part of those costs to customers. The September survey indicated that firms increased employment as they responded to stronger activity, providing an additional source of household income and supporting consumption.
There are limits to this process. If energy prices remain elevated for a prolonged period, companies may eventually find it harder to pass the entire increase through to customers. Households also face higher fuel, transport and utility costs, which can reduce disposable income and weaken consumption.
Recent consumer confidence data already show some deterioration as higher energy prices affect household expectations. This creates a potential weakness beneath the stronger business figures because consumer spending remains an important component of the European economy.
The Energy Shock Is Still a Monetary Policy Problem
The resilience of economic activity creates a difficult problem for the European Central Bank. A weak economy facing higher energy prices would normally create a difficult tradeoff for monetary policymakers, because raising interest rates to control inflation could further weaken demand.
The latest data complicate that calculation. Stronger business activity means the economy appears capable of absorbing some monetary tightening, while rising energy prices are creating renewed inflation pressure. The September projections from the European Central Bank expect inflation to peak at 3.6 percent in the final quarter of 2026 before declining as the energy shock fades.
Markets have consequently increased expectations for additional interest rate increases. But ECB officials have emphasized that monetary policy will not automatically respond to every increase in energy prices. The central bank is assessing whether the shock remains concentrated in energy or begins to spread more broadly through wages, services and other prices.
This distinction is critical. If companies simply absorb some higher energy costs and inflation returns towards target once energy prices stabilize, the shock could remain relatively temporary. If higher energy prices become embedded in wages and service prices, the ECB would face a more persistent inflation problem.
So far, there is evidence that the second round of effects remains limited. Wage pressures have not accelerated to the extent that would indicate a broad inflation spiral, although the risk remains if energy prices stay high for longer.
Germany and France Show Different Forms of Resilience
The performance of Europe's two largest economies also helps explain the broader picture. Germany has faced considerable pressure from weak industrial competitiveness, high energy costs and subdued exports, making its ability to maintain expansion particularly significant. Recent business surveys have nevertheless shown improving manufacturing sentiment, while infrastructure spending and government support are providing additional demand.
France is benefiting more strongly from services, where activity has rebounded despite higher energy costs. The French government has also introduced targeted support measures for households and businesses affected by higher fuel prices, although such measures increase pressure on already strained public finances.
These differences show why the euro area's resilience cannot be attributed to a single factor. Some economies are being supported more by services, others by manufacturing, public investment or exports. The common feature is that the energy shock has not yet overwhelmed the combination of domestic demand, employment and business activity.
That resilience remains conditional. The European Central Bank's own scenarios show that a longer and more severe energy disruption would produce significantly weaker growth and substantially higher inflation.
For now, however, Europe's economic performance suggests that the region has entered the latest energy crisis with stronger defenses than during earlier disruptions. Diversified energy supplies, improved infrastructure, a relatively strong services economy, recovering industrial activity and continued employment growth are helping absorb the initial pressure.
The crucial question for the coming months is not whether Europe can withstand a temporary energy shock, but whether businesses and households can continue absorbing higher costs if the disruption lasts longer. The September data provide evidence of resilience, but they do not remove the underlying risks created by energy prices, inflation and geopolitical uncertainty.
(Source:www.thedailyguardian.com)
