Russian Invasion Deals Blow to European Business Confidence

Despite the high level of uncertainty, the first large-scale ground war in Europe since World War II should cause a sharp increase in inflation and a slowdown in growth this yearaccording to most economists. In Germany, Europe’s largest economy, a panel of economists who advise the government cut their 2022 gross domestic product growth forecast on Wednesday from 4.6% to 1.8%, citing the war as the reason.

“Our world changed overnight on February 24 with Russia’s invasion of Ukraine,” said

Martin Brudermüller,

chairman of chemicals giant

BASF SE

in a speech to investors Monday. “There is a brutal war raging in Europe.”

A monthly survey conducted by the European Union found that sentiment among businesses and households weakened to its lowest level in a year during the early weeks of March. This was largely a result of a sharp fall in consumer confidence as households quickly marked down their expectations for economic growth over the coming 12 months.

Among businessesthe response varied. Service providers said they were more confident about their prospects, reflecting the progressive reopening of the hospitality sector as the governments across the region eased or lifted Covid-19 pandemic restrictions. By contrast, manufacturing companies became more pessimistic about their prospects.

Across retailing and construction the measure of confidence remained above its long-term average going back to 1990. That is a sign that businesses may not pull back sharply on investment spending, which has been slower to recover in the eurozone than it has in the U.S.

The resilience of business confidence in the first month of the war suggests the eurozone economy may continue to grow in coming months, and offers some comfort to economic policy makers in the currency area.

In an interview with Politico conducted before the EU’s survey was released—but after national polls from Germany and France had been published—European Central Bank Chief Economist

Philip Lane

said the greatest threat to growth would come “if this is a trigger for a big decline in sentiment.”

“All economies operate on confidence, and what we see now in terms of these first readings of confidence indicators is a concern,” he said.

The survey also suggests the effect of the war could vary from country to country, with economies such as Germany and Italy that rely on manufacturing and are dependent on Russian energy imports facing a bigger shock than others where services and consumption account for a larger share of GDP.

The EU survey indicated that businesses only modestly trimmed their hiring plans in the first weeks of the war, having planned the most aggressive recruitment on record in February. Again, the response varied by sector and households anticipated a more negative turn in the jobs market over coming months.

“The decline was due to worsened employment plans in industry, retail trade and construction, while managers in the services sector expected employment to increase in their firms over the next three months,” said the European Commission, which compiled the survey.

The survey sent fresh alarm signals on the outlook for inflation. Manufacturers, retailers, service providers and construction companies all reported that they expect to raise their prices at the fastest pace on record over the coming three months, while consumers also expect to see a surge in prices.

The ECB is already grappling with the highest inflation rate since records began in the late 1990s, and expects the rise in consumer prices to accelerate over coming months, driven by energy and food items.

Earlier this month, the central bank said it would reduce its purchases of government bonds over the coming three months, and may end them entirely by September to contain a pickup in the annual rate of inflationwhich stood at 5.9% in February.

The ECB said it could raise its key interest rate some time after it stops buying bonds, while the Federal Reserve has signaled it is likely to raise its key rate six more times before the end of this year.

Write to Paul Hannon at paul.hannon@wsj.com