Europe experiences climateflation as prolonged drought inflates prices

May 24, 2023|Written by Scott Speer|European Central Bank

Europe is experiencing the highest inflation rates of the 21st century, while Spain, France, and northern Italy, are in the midst of another severe drought. Climate change policies are being scrutinised with increasing intensity, and many see extreme weather driven by climate change and inflation as two sides of the same coin, otherwise known as climateflation.

In 2012, the World Bank reported that “severe droughts drive food prices higher, threatening the poor” and in a 2016 report, the European Central Bank (ECB) concluded that “droughts increase headline inflation for a number of years”.

Climateflation is a term increasingly being used, describing price increases that are a direct result of climate change. Reports from the ECB have previously examined and identified the different effects climate change has on price: fossil fuel dependency (fossilflation); short-term supply bottlenecks for critical materials required for the green transition (greenflation); and physical climate impacts (climateflation) which can impact on food prices.

Positive Money UK has pointed to Spain’s olive oil production as a clear example of climateflation. Spain accounts for 45% of the world’s supply and severe droughts in 2022 resulted in prices being driven up by 25%. A recent report from the ECB showed that if heatwaves occur in Spain during summer, inflation in the entire euro area is driven significantly upwards. The report noted that price stability mandates are being materially affected by increasing weather shocks.

Climateflation has not been limited to olive oil. A Spanish farmers’ association has forecast that cereal crops will fail entirely in four regions this year. To combat the effects of severe drought, the Spanish government has recently approved an unprecedented €2bn package, allocated to build new infrastructure to tackle water shortages and a range of support for agriculture. In Italy, a newly formed emergency government committee successfully passed relief measures worth over €100mn to address the effects of drought.

Alongside the emergency measures for climate-related events, central banks have continued to raise interest rates in the hope of dampening inflationary pressures. According to Katie Kedward, a policy fellow at the University College London, this demand-side technical fix for inflation exacerbates the cost-of-living crisis and delays the green transition, creating a disadvantage for renewable technology because it requires significant initial investment.

Despite the increasing climate-related shocks such as southern Europe’s present droughts, supply-side initiatives such as climate-adjusted capital requirements have not yet materialised.

The Bank of England had planned to decarbonise its asset purchases but put plans on hold earlier this year, while in 2021 the Bank of Japan began targeting refinancing options to steer finance to greener activities. Also in 2021, the ECB released its climate plan which, among other commitments, aimed to have clear criteria based on climate risk and considerations when buying corporate bonds and collateral.

This page was last updated May 24, 2023

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