Spring economic forecast 2008-2009: growth moderates, price pressures a worry but, overall, EU weathers external headwinds rather well

Spring economic forecast 2008-2009: growth moderates, price pressures a worry but, overall, EU weathers external headwinds rather well

Growth in the European Union is expected to ease to 2% in 2008 and 1.8% in 2009 from 2.8% in 2007 (1.7% and 1.5% in the euro area from 2.6% in 2007), according to the Commission's spring economic forecast. The moderation in growth results from the persisting turmoil in the financial markets, the marked slowdown in the United States and soaring commodity prices, all of which are taking their toll on global activity. The EU economy is holding up relatively well thanks to sound fundamentals and is expected to create 3 million new jobs in 2008-2009 on top of the 7½ million in 2006-2007. But consumer price inflation is expected to surge temporarily to 3.6% this year in the EU against 2.4% in 2007 due to soaring energy and food prices, before coming down to an expected 2.4% in 2009 ( equivalent figures for euro area are 3.2% and 2.2% versus 2.1% in 2007).

"Economic growth is moderating in the EU and euro area and the current, imported inflationary pressures are a matter of concern. Whilst our economies have proved resilient to the external shocks so far, and we expect continued, albeit slower, job creation, we need to stick to sound macro-economic policies and carefully avoid starting an inflation spiral that would particularly affect low income families", said Joaquín Almunia, Economic and Monetary Affairs Commissioner.

The Commission’s economic forecast published today projects economic growth at 2.0% in 2008 and 1.8% in 2009 in the EU (1.7% and 1.5% for the euro area). This is ½ percentage point (p.p.) lower than predicted in the autumn forecasts.[1] The final results for 2007 were 2.8% for the EU and 2.6% for the euro area.

External shocks are taking their toll...

The weaker economic outlook follows from continued distress in the financial markets, a marked slowdown in the US - which the Commission expects to grow 0.9% this year and 0.7% in 2009 versus 2.2% in 2007 – soaring commodity prices and a resulting cooling of global growth.

The Commission's baseline scenario assumes that uncertainty about the size and location of credit losses will prevail until the end of this year, before gradually petering out during the first half of 2009. The fact that we have not seen much of an effect so far could imply either than transmission lags are longer than expected or that the resilience has improved further than we think in the EU.

....making inflationary pressures a clear worry

Headline inflation increased significantly since the autumn to reach 3.8% in March, in annual terms, in the EU (3.6% in the euro area). This reflects a sharp increase in global energy and food prices partly cushioned by the stronger euro. In view of this, the Commission is now forecasting average inflation this year at 3.6% in the EU and 3.2% in the euro area. After peaking in the second quarter of 2008 in the EU, inflation is nevertheless expected to come down to lower levels to 2.4% in 2009 on average (2.2% in the euro area).

EU economy proves resilient

The EU economy is still in a relatively good position to weather the global headwinds on the back of improved fundamentals, reflected e.g. in the absence of macroeconomic imbalances and healthy public finances. Both the average public deficit and current account position were below 1% of GDP in 2007, even though differences across Member States remain large. Households and enterprise balance sheets have improved markedly in recent years and the unemployment rates for the EU and euro area are the lowest in more than 15 years.

However, the EU economy will not escape unscathed. Investment growth is weakening due to a cooling-off of overvalued housing markets and the cyclical slowdown. Private consumption growth is also set to slow with employment and real wage growth decelerating this year and consumer confidence in steady decline.

Improvements in the labour market and public finances come to a halt

Following on the strong improvement in 2006-2007 momentum, the labour market is now softening and employment growth is expected to be halved this year, down from 1.7% in 2007 to 0.8% this year and 0.5% next. The unemployment rate should bottom out at 6.8% in the EU this year (7.2% in the euro area).

Despite the easing in the labour market situation, wage growth is expected to accelerate from 2.9% in 2007 to 3.8% this year, temporarily boosted by some catching-up measures in e.g. Germany, before decelerating again to 3.5% next year.

After recording the best result since 2000 at 0.9% of GDP (0.6% in the euro area), the average public deficit is expected to increase again in 2008 to 1.2% of GDP in the EU (1.0% in the euro area) due to more moderate activity in general and tax cuts in some countries. For 2009, based on a no-policy-change assumption, the deficit should broadly stabilise. In structural terms, the fiscal consolidation is also projected to stall in 2008.

Downside risks prevail

The major downside risks relate to the still ongoing turmoil in the financial markets which may reinforce the US downturn further. The uncertainty is still large as regards the impact of the crisis on the real economy. A larger impact could accentuate the ongoing correction of some housing markets notably that of the US, but also within the EU, with the subsequent risk of putting balance sheets under increasing strain. Risks stemming from imbalances in some of the countries with sizeable current-account deficits and/or external debts could be fuelled by shifts in risk preferences following a further deepening and/or widening of the financial crisis. Further downside risks relate to a disorderly unwinding of global imbalances in general, even if the current outlook already predicts an improvement in the US current-account deficit. Future commodity prices could entail further negative, but also positive surprises.

Overall, risks are more balanced than in the autumn 2007 forecast. Nonetheless, the balance of risks for the growth outlook continues to be tilted to the downside, especially for 2009, while the risks for inflation are somewhat on the upside.
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