Climate risks: no longer the tragedy of the horizon

9 July 2025

By Sabine Mauderer and Livio Stracca^[1]

Climate-related risks are an immediate concern for financial stability and economic growth. Yet until very recently, there have been no tools to systematically assess their short-term effects. The innovative short-term scenarios devised by the NGFS – which brings together central bankers and supervisors from around the world to work on climate-related issues – fill this gap. The new scenarios offer financial institutions a comprehensive framework for quantifying the impacts that transition and physical risks could have on the economy by 2030. They reveal that a series of extreme climate events could cause euro area GDP to fall by up to 5% – a downturn similar in magnitude to the economic impact of the Global Financial Crisis. This blog post provides a deep dive into the results of new NGFS short-term scenarios for the euro area.

Why climate risks matter in the short term

Climate-related risks demand immediate attention. The European Commission estimates that droughts in Europe lead to losses of €9 billion every year, nearly 5% of the 2024 annual EU budget – and these losses are only expected to increase in the near future.^[2] Recent ECB research on drought-related surface water scarcity supports these expectations. The lack of surface water is the most significant nature-related threat to economic activity in the euro area, with up to 15% of gross economic output at risk.^[3]

Additionally, the euro area’s reliance on a steady supply of critical minerals for the green transition heightens its vulnerability.

The vanishing horizon: climate risks by 2030

The NGFS short-term scenarios focus on a five-year horizon, which aligns closely with the decision-making horizons of central banks, financial institutions and supervisors. The scenarios show how natural hazards and climate policies affect the economy and inflation. They also account for the reaction of the financial system by assessing how financing conditions might change, and which economic sectors could face pressure to adjust to climate shocks.

A major innovation of the scenarios is their approach to modelling physical risks. For the first time, the NGFS captures the impact of compounding extreme weather events and how they propagate across borders through international supply chains.

To illustrate the impact of climate risks, the framework includes four short-term scenario narratives, as well as a baseline scenario that accounts for countries’ existing climate commitments (known in the Paris Agreement as the nationally determined contributions). The scenarios combine different assumptions on climate policy trajectories and physical risk.

• The Highway to Paris scenario assumes a coordinated and timely transition to a net-zero economy.
• The Sudden Wake-Up Call scenario simulates a delayed and abrupt transition starting in 2027.
• The Disasters and Policy Stagnation scenario captures severe and compounding acute weather events across continents.
• The Diverging Realities scenario assesses how the impact of natural hazards occurring in emerging economies – including those rich in raw materials critical for the green transition – spills over to advanced economies through disruptions in supply chains.

Short-term climate risks in the euro area

The new NGFS scenarios reveal that the near-term impact of severe weather events on the euro area is significant – whether these events occur within or outside Europe. In the Disasters and Policy Stagnation scenario, a series of natural hazards affects all European countries, starting with heatwaves, droughts and wildfires in 2026, followed by a combination of floods and storms in 2027. The compounding effects of these hazards could lead to a decline in euro area annual GDP of up to 4.7% by 2030. As production is disrupted and borrowing gets more expensive for vulnerable industries, inflation increases.

Yet, even if adverse climate events were to happen elsewhere, they would still affect euro area output and increase the costs of transitioning to a low-carbon economy. In the Diverging Realities scenario, euro area annual GDP suffers losses of up to 1.8% from climate shocks affecting regions rich in raw materials and disrupting the supply of critical minerals to the euro area.

With ambitious climate policies already in place, however, the euro area would gain from an early and globally coordinated net-zero transition. In the Highway to Paris scenario, carbon tax revenues are invested effectively in green technologies, and euro area GDP and employment slightly increase. The green transition has limited inflationary effects. The euro area position in this scenario stands out because it has previously adopted ambitious climate policies, particularly the European Green Deal, which targets a 55% reduction in greenhouse gas emissions by 2030 compared with 1990 levels. Transition efforts in this scenario would lead to a 0.5% contraction of global economic activity by 2030. However, delaying the transition by three years, as envisaged in the Sudden Wake-Up Call scenario, leads to euro area output losses and heightened inflationary pressures. The NGFS scenarios thus indicate that a globally coordinated net-zero effort would safeguard the euro area’s economic interests over the next five years.

From analysis to action

The five-year horizon of the NGFS short-term scenarios aligns closely with the horizons of the ECB’s work on monetary policy, financial stability and banking supervision. The scenarios will support exercises such as climate stress testing. They can also feed into monetary policy analysis, where climate shocks or abrupt transition policies may influence inflation or output.

The above findings underscore the need for comprehensive and robust climate risk assessments in the face of intensifying climate events. The scenarios are still evolving and will be refined further based on feedback from users. For example, they do not currently capture nature-related risks such as biodiversity loss. Future analyses could take a more comprehensive approach and consider the impact of potential tail risks like water scarcity on financial and economic stability. More work is required to understand and navigate such a broad array of risks. That way, we can stay ahead of climate risks and help manage the economic impacts of climate change more effectively.

The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.

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