Europe’s summer of extreme heat exposes contradiction in economic policy

Key points

• Europe’s hottest summer on record is estimated to have caused 35,000 excess deaths, burned more than 668,000 hectares and left 38% of the EU affected by drought.

• Heatwaves, wildfires and water shortages could have cut eurozone output by about 1%, as agriculture, energy production and transport all suffered.

• The ECB has warned that climate shocks, including a possible El Niño, could drive up food prices and inflation, while Fitch says extreme weather may push up sovereign borrowing costs.

• Policymakers face growing calls to invest in climate resilience, as experts warn that delaying adaptation and mitigation will leave governments, banks and households facing even higher costs.

Europe might be emerging from its hottest summer yet but the impact is still being felt economically.

The summer of extreme heat was felt across the continent, contributing to an estimated 35,000 excess deaths, more than 668,000 hectares of burnt land and drought conditions across 38% of the Eurobloc.

“This summer is really some kind of late wake-up call for all those who are still sleeping. Physical risk is something to consider now and not just in the future,” Jean Boissinot, director of risk analysis at Banque de France’s (BdF) prudential supervision authority (ACPR), told Green Central Banking.

“What was really noteworthy is that it was really a continental event. Beyond agriculture, it was affecting energy production, transport and many different sectors, in many different places across the continent.” 

Economists now estimate that the summer of heatwaves, drought and wildfires may have cost the eurozone around €180bn or 1% of GDP due to lower crop and dairy yields, reduced energy efficiency and reduced transport capacity. One report from Triodos Bank warns that Europe’s growth will be flat this year and next summer could be even worse due to the compounding effects of El Niño.

The European Central Bank (ECB) has also warned that El Niño could increase inflation due to rising food prices and a disruption in supply, with one of its papers confirming that extreme climate events could lower production levels in some regions.

It’s not just central bank policy that could be impacted. Fitch Ratings agency has cautioned that climate risk from extreme weather events could become a driver of sovereign borrowing rates in the coming years. And it’s often fiscal budgets that come under pressure when a climate crisis hits. For countries that are already running deficits, this adds an extra layer of complexity.

Climate risk no longer a future concern 

The costs from the summer are still mounting, as officials assess the damage to crops, agriculture and buildings affected by cracks caused by soil expansion, which can cause billions in damage.

The direct and indirect impact on companies and banks is still being assessed. In France, the hope is that the summer’s extreme weather events were cushioned by insurance, but it’s too early to know for sure, said Boissinot.

For the Banque de France, the main goal now is to make sure that banks and insurance companies understand future risks, including those from climate change.

“It’s really about gaining a better understanding of the risk, and then, beyond related supervisory expectations, banks may want to use that as a business driver,” said Boissinot.

Climate and nature risk has until now been thought of as a forward-looking exercise, something that would arrive in the future. But now, experts tell Green Central Banking, that risk is here.

However, the worst may be yet to come, according to Ernst Hobma, an economics researcher at Triodos Bank and a co-author of the bank’s report on the economic impact of the heat in Europe.

“We don’t know exactly how big it’s going to be, and we don’t know exactly when and which tipping point will be triggered and how they’ll affect each other. But we have estimates, and they go from terrible to catastrophic.”

For Hobma, there’s no debate about whether climate change will have an economic impact, which is why “it would make a lot of sense if central banks became a lot more proactive,” he said. 

“I frankly think it’s crazy that we’re still allowing supervised banks to finance the expansion of fossil fuels.” 

Since fossil fuels are one of the major drivers of climate and nature risk, there is a strong argument to be made from a precautionary perspective about why central banks can and should limit financial flows to the fossil fuel industry, he added. 

Climate resilience comes with a price – but so does inaction 

Experts say that now is the time for Europe to respond and invest in the measures needed to help protect the region from future risks that will undoubtedly hit in the coming years.

In the paper Hobma co-authored about the summer heat, he and his co-authors criticise Brussels for not taking more action in light of the shocks from the summer. Instead of acting, governments have created a “doom loop” by loosening policies intended to prevent the damage.

This isn’t because anyone denies that the events of the summer are real, “but because the economic logic that produced today’s climate change is treated as sacrosanct even as the damage it produces becomes undeniable.”

The EU has softened some of its green measures, including emissions disclosure requirements, and is currently looking to simplify regulation for the banking industry in a bid to create a more competitive environment. 

While the summer’s slowdown isn’t enough to create lasting damage to the EU’s economy, it could accumulate and possibly even accelerate if action isn’t taken, Triodos Bank says.

“Every year adaptation without mitigation is a year borrowed against a hotter baseline, and every policy loosened to protect this year’s growth number is a subsidy paid by whoever is facing the next heatwave.”

Experts and NGOs have been calling for more coordination between finance ministers, central bankers and other key players.

“If you want to lower emissions quickly, then you need to lower energy demand, and that’s a conversation that should be led by Brussels, but credit guidance could help,” said Hobma. 

“Frankfurt and Brussels need to be talking, I think, about how to engage in such credit guidance as a complement to industrial policy.”

Rethinking the real cost of the green transition 

One of the key themes heading into the fall for policymakers is climate resilience.

“This summer is also telling us that when we say transition is not just transition to net zero, it’s also transition to climate resilience,” said Boissinot.

“It’s not just a CO2 emissions story,” but rather about considering the transition to net zero and climate resilience when thinking about bank transition plans and engagement with clients and borrowers, he added.

Bruno De Conti, a professor at the University of Campinas and senior researcher at Positive Money, urges finance ministers and governments to think about reallocating funding towards climate adaptation and mitigation. The tensions between extreme weather events and austerity policies  by some governments create a contradiction, he adds.

Governments try to save money but end up diverting funds from other areas when a catastrophe arises, which then reduces the speed of investment that is needed for a green transition. 

“There is a kind of a vicious circle because governments are saving money, but in doing that, they are postponing the solutions; they are postponing the green transition,” he said.

Instead, policymakers should treat the green transition not as an ordinary budget expenditure, but as a means of not only protecting its citizens, but also a means of saving money in the future. Reinvestment would ultimately strengthen public finances by reducing the costs of future extreme weather events.

“Spending now is saving money for the future and not spending now… implies higher costs in the very near future,” he said. 

With economic shocks compounding, the impact on the economy is likely to get worse, said Uuriintuya Batsaikhan, a macroeconomic specialist at thinktank Bruegel. What is unknown is just how much these shocks are going to compound.

While more investment in mitigation and adaptation finance is needed, so too are shock absorption responses to extreme events, such as parametric insurance. Governments and central banks also need to think about these risks in their long-term planning.

“It’s very clear that acute events will happen more and more. They are going to be worse and worse, and more and more frequent,” she said. “So, are you going to be constantly responding, or are you going to be planning long term?”

Written by

Moriah Costa is the Editor-in-Chief of Green Central Banking and has over a decade of experience writing about banking and finance. She is an award-winning American journalist based in Paris and has written for major international publications, including Reuters, The Guardian, and S&P Global. Having grown up in water-stressed Arizona, she has always had a strong interest in bringing awareness to climate and environmental issues.