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The EU economy is recovering from the pandemic recession faster than expected. As vaccination campaigns progressed and restrictions began to be lifted, growth resumed in the spring and continued unabated through the summer, supported by the reopening of the economy. Despite rising headwinds, the EU economy is expected to continue growing over the forecast horizon, reaching a growth rate of 5%, 4.3% and 2.5% in 2021, 2022 and 2023 respectively . Eurozone growth rates are expected to be the same as the EU in 2021 and 2022, and 2.4% in 2023. This outlook is highly dependent on two factors: the evolution of the COVID-19 pandemic and the rate at which supply adjusts. the rapid recovery in demand following the reopening of the economy.
The European economy is back on an expansionary path faster than expected
At nearly 14% in annual terms, the EU’s GDP growth rate in the second quarter of 2021 was the highest on record – as high as the unprecedented fall in GDP in the same period last year, when of the first wave of the pandemic. The EU economy returned to pre-pandemic production levels in the third quarter of 2021 and shifted from recovery to expansion.
Domestic demand should continue to drive this expansion. Improving labor markets and the expected drop in savings should contribute to a sustained pace of consumer spending. The implementation of the Recovery and Resilience Facility (RRF) is also beginning to play an important role in boosting private and public investment.
However, the growth momentum is facing new headwinds. Bottlenecks and global supply disruptions are weighing on activity in the EU, especially in its highly integrated manufacturing sector. Additionally, after falling sharply in 2020, energy prices, particularly natural gas, have risen at a tumultuous pace over the past month and are now well above pre-pandemic levels. This should weigh on consumption and investment.
The labor market should continue to improve
EU labor markets have improved markedly thanks to the easing of restrictions on consumer-related activities. In the second quarter of this year, the EU economy created around 1.5 million new jobs, many workers left job retention programs and the unemployment rate fell. However, total employment in the EU was still 1% below its pre-pandemic level.
Since then, unemployment has fallen further. At 6.8%, the EU unemployment rate in August was just above the rate recorded at the end of 2019. Data released after the forecast deadline shows it fell slightly further in September . The Commission’s business surveys reveal the emergence of pockets of labor shortages, particularly in the sectors where activity is most dynamic. The longer these last, the greater the risk that they will dampen activity and fuel inflation through wage pressures.
Forecasts predict that employment in the EU will grow at a rate of 0.8% this year, 1% in 2022 and 0.6% in 2023. Employment is expected to exceed its pre-crisis level l next year and expand in 2023. The EU is expected to grow from 7.1% this year to 6.7% and 6.5% in 2022 and 2023, respectively. In the euro zone, it is projected at 7.9%, 7.5% and 7.3% over the three years.
The improved growth outlook points to lower deficits in 2021 than forecast in the spring. After reaching 6.9% of GDP in 2020, the aggregate EU deficit is expected to narrow slightly to 6.6% in 2021, thanks to the still high fiscal support at the start of the year.
With support measures and the operation of automatic stabilizers expected to dissipate as economic expansion continues, the aggregate EU deficit is projected to halve to around 3.6% of GDP in 2022 and further decline to 2.3% in 2023.
After reaching around 92% in the EU (99% in the euro area), the aggregate debt-to-GDP ratio is expected to stabilize broadly this year and start declining in 2022, reaching 89% of GDP in 2023 (97 % in the euro zone).
Temporary global price pressures push inflation to highest level in a decade
After several years of low inflation, the strong recovery in economic activity in the EU and in many advanced economies has been accompanied by an acceleration in inflation that exceeded forecasts.
Annual inflation in the euro zone rose from -0.3% in the last quarter of 2020 to 2.8% in the third quarter of 2021. The October reading was 4.1%, a rate equaled only once since the release of euro area inflation data. started in 1997.
This sharp acceleration in inflation is primarily driven by soaring energy prices, but also appears to be linked to a wide range of post-pandemic economic adjustments, suggesting that the current high levels are largely transitory.
Eurozone inflation is expected to peak at 2.4% in 2021, before falling back to 2.2% in 2022 and 1.4% in 2023, as energy prices are expected to gradually stabilize. For the EU, inflation is expected at 2.6% in 2021, 2.5% in 2022 and 1.6% in 2023.
Uncertainty and risks surrounding the growth outlook remain very high
Although the impact of the pandemic on economic activity has eased considerably, COVID-19 has not yet been defeated and the recovery is highly dependent on how it evolves, both inside and outside the the EU. In light of the recent upsurge in cases in many countries, the reintroduction of restrictions impacting economic activity cannot be ruled out. In the EU, this risk is particularly significant in Member States where vaccination rates are relatively low.
Economic risks also relate to the potentially prolonged impact of current supply constraints and bottlenecks.
The main upside risk to the growth outlook relates to potential efficiency gains and lasting productivity gains triggered by pandemic-induced structural changes. The investments encouraged by the FRR and the accompanying structural reforms will play a decisive role in this regard. Overall, the balance of risks surrounding this forecast has tilted to the downside.
Inflation could turn out to be higher than expected if supply constraints are more persistent and if wage increases above productivity are passed on to consumer prices.
College members said:
Valdis DombrovskyExecutive Vice President for an Economy that Works for People, said, “The European economy is rebounding strongly from the recession, with an expected growth rate of 5% this year. Our measures to cushion the blow of the pandemic and to step up vaccinations across the EU have clearly contributed to this success. But now is not the time for complacency: we continue to face uncertainty in the face of this virus and there are certain risks to be faced. Last but not least, we need to tackle bottlenecks in supply chains, as well as soaring energy prices that will affect many households and businesses across Europe. We also need to monitor inflation closely and adjust our policies if necessary. To stay on track, we now need to focus on rolling out the investments and reforms planned under the Recovery and Resilience Facility to boost our economic potential.”
Paulo GentiloniCommissioner for the Economy, said: “The European economy is shifting from recovery to expansion, but now faces headwinds. An unprecedented political response has cushioned the impact of COVID-19 on workers and businesses and a successful vaccination campaign has allowed our economies to reopen since the spring. This has fueled a growth spurt, which in turn is helping to stabilize our public finances. And with the support of NextGenerationEU, public investment is set to reach its highest level in over a decade. Three main threats weigh on this positive image: a marked increase in COVID cases, most acute in areas where vaccinations are relatively low; rising inflation, mainly due to soaring energy prices; and supply chain disruptions that are weighing on many sectors. We must remain vigilant and act as needed to ensure that these headwinds do not derail the recovery. »
This forecast is based on a set of technical assumptions regarding exchange rates, interest rates and commodity prices with a cut-off date of October 19. For all other incoming data, including government policy assumptions, this forecast considers information up to and including October 25. Unless new policies are credibly announced and specified in sufficient detail, the projections assume no policy changes.
The European Commission publishes each year two global forecasts (spring and autumn) and two intermediate forecasts (winter and summer). The interim forecasts cover annual and quarterly GDP and inflation for the current year and the following year for all Member States, as well as EU and euro area aggregates.
The European Commission’s Winter 2022 Economic Forecast will update GDP and inflation projections and is expected to be presented in February 2022.