Portugal leads the European response to the energy crisis

The price of Brent crude in euros has already risen by 42% since the initial US and Israeli strikes on Iran, whilst the price of natural gas has soared by more than 60% to date. In response, Europe has introduced a number of fiscal measures more abruptly than it did four years ago, following Russia’s invasion of Ukraine, which also caused energy costs to rise suddenly.

In a report published on Thursday, Oxford Economics warns, however, that the response from European governments will be much more modest than in 2022, and that it is unlikely to affect the consultancy’s macroeconomic projections for the region.

“European governments are reacting much more quickly to rising energy costs than in previous crises”, writes the chief economist for Europe, Angel Talavera. “But unless prices remain much higher for longer, the scale of this intervention will likely be very modest compared to the massive fiscal response of 2022”, he notes.

Portugal is among the first European countries to take action. Last week, the Government announced a temporary reduction in tax on petroleum products, a short-term tax relief measure that places the country at the forefront of the European response, alongside Greece, which has imposed a cap on profit margins for fuel and supermarkets, and Croatia, which has set maximum retail prices for petrol and diesel.

Spain, Germany and Austria are also considering similar packages, reveals the Oxford Economics report, but none have been approved. “The economies of Southern Europe, which have stronger fiscal positions than four years ago, are leading the fiscal response this time”, emphasises Angel Talavera.

The improvement in the public finances of southern European countries is no mere detail for the economist. The British consultancy highlights that it is no coincidence that it is precisely these countries that have already acted or are about to do so.

“Greater fiscal space means that governments can play a much more active role in fiscal terms this time: by mobilising countermeasures early on, they hope to limit the damage and send the right signal to voters, who have cited high prices as their main concern for years, without causing a significant impact on their countries’ public finances”, reads the document to which ECO had access.

Portugal is a case in point. With a budget balance that is significantly better than in 2021, it now has the leeway to take action without jeopardising fiscal consolidation.

Faster but with less firepower

The context is very different from that of the 2021–2022 crisis, when governments took months to react after prices began to rise. This time, the measures are intentionally small and temporary. The total cost of what has been announced so far is in the region of hundreds of millions of euros, an almost negligible fraction compared to the €500 billion to €600 billion that European Union member states spent on support measures during those two years.

“The measures announced are temporary in nature and very modest in scale”, Oxford Economics notes in the report. The focus this time is on reductions in fuel taxes and the expansion of social support for lower-income households.

The European Commission is also monitoring the situation. Brussels has already suggested guidelines to Member States to reduce taxes and levies on electricity and is considering the possibility of setting a cap on the price of natural gas – a measure that was already implemented in December 2022, when TTF gas contracts reached 150 euros per megawatt-hour (MWh).

Natural gas is currently trading above €51 per MWh, and Oxford Economics does not take the prospect of a gas price cap very seriously: “We view this more as a signalling mechanism to demonstrate a readiness to act should the situation worsen, rather than as a policy under serious consideration at this stage.”

There is, however, one variable that could change everything: the European Central Bank (ECB). After raising interest rates between 2022 and 2024 to combat inflation, the institution led by Christine Lagarde achieved a soft landing and has kept rates unchanged for almost a year.

The risk is that an overly generous response could complicate the path to disinflation. “By adopting modest fiscal measures, eurozone governments appear to be trying to support households without compromising the ECB’s disinflation strategy”, the report concludes.

If energy prices continue to rise or remain high for longer than expected, that balance may be difficult to maintain — and governments may be forced to go further.