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The outlook for the EU economy before the outbreak of the war predicted a prolonged and robust expansion. But Russia’s invasion of Ukraine posed new challenges, just as the Union had recovered from the economic impacts of the pandemic. By putting further upward pressure on commodity prices, causing further supply disruptions and increasing uncertainty, the war is exacerbating pre-existing headwinds to growth that were previously expected to ease. This has led the European Commission to revise EU growth prospects downwards and inflation forecasts upwards.
Slowing growth as war exacerbates pre-existing headwinds
EU GDP is expected to remain in positive territory over the forecast horizon, thanks to the combined effect of post-lockdown reopenings and strong policy measures taken to support growth during the pandemic. Namely, the post-pandemic reopening of contact-intensive services, a strong and still improving labor market, lower savings accumulation, and fiscal measures to offset rising energy prices should support the private consumption. Investment should benefit from the full deployment of the Recovery and Resilience Facility and the implementation of the accompanying reform programme.
Real GDP growth in both the EU and the euro area is now expected at 2.7% in 2022 and 2.3% in 2023, compared to 4.0% and 2.8% (2.7% in Eurozone), respectively, in the Winter 2022 Interim Forecast. last year, which adds about 2 percentage points to this year’s annual growth rate. Production growth for the year was reduced from 2.1% to 0.8%.
The main blow to the world and European economies comes from the prices of energy raw materials. Although they had already risen considerably before the war, from the low levels recorded during the pandemic, uncertainty over supply chains has pressured prices upwards, while increasing their volatility. This is the case for food and other basic goods and services, with household purchasing power declining.
War-induced logistics and supply chain disruptions, as well as rising input costs for a wide range of raw materials, add to global trade disruptions caused by drastic COVID containment measures -19 still enforced in parts of China, weighing on production.
Energy prices push inflation to record highs
Inflation has been accelerating since the beginning of 2021. From 4.6% year-on-year in the last quarter of 2021, it rose to 6.1% in the first quarter of 2022. Headline inflation in the euro zone jumped to 7 .5% in April, the highest rate in the history of the monetary union.
Inflation in the euro area is projected at 6.1% in 2022, before falling back to 2.7% in 2023. For 2022 as a whole, this represents a considerable upward revision from the interim forecast of winter 2022 (3.5%). Inflation is expected to peak at 6.9% in the second quarter of this year and gradually decline thereafter. For the EU, inflation is expected to rise from 2.9% in 2021 to 6.8% in 2022, then fall back to 3.2% in 2023. Average underlying inflation is expected to exceed 3% in 2022 and 2023 , both in the EU and in the euro area.
Strong and still improving labor market
The labor market is approaching the new crisis on solid foundations. In 2021, more than 5.2 million jobs were created in the EU economy, which attracted nearly 3.5 million additional people to the labor market. In addition, the number of unemployed fell by nearly 1.8 million people. Unemployment rates at the end of 2021 fell below previous record highs.
Labor market conditions are expected to improve further. Employment in the EU is expected to grow by 1.2% this year, although this annual growth rate is boosted by strong momentum in the second half of last year. People fleeing the war in Ukraine to the EU are only expected to enter the labor market gradually, with tangible effects only becoming visible from next year.
Unemployment rates are expected to decline further, reaching 6.7% this year and 6.5% in 2023 in the EU and 7.3% and 7.0% in 2022 and 2023 respectively in the euro area.
Public deficits continue to fall but the costs linked to the war are increasing
Despite the cost of measures to mitigate the impact of high energy prices and to support people fleeing Ukraine, the EU’s overall government deficit is expected to decline further in 2022 and 2023, temporary support measures linked to COVID-19 continuing to be removed. From 4.7% of GDP in 2021, the EU deficit is expected to fall to 3.6% of GDP in 2022 and 2.5% in 2023 (3.7% and 2.5% in the euro area).
After declining in 2021 to around 90% (97% in the euro area) from the historic peak of around 92% of GDP in 2020 (almost 100% in the euro area), the aggregate debt-to-GDP ratio of the eastern EU is expected to decline to around 87% in 2022 and 85% in 2023 (95% and 93% in the euro area, respectively), remaining above the pre-COVID-19 level.
Uncertainty and risks depend on the evolution of the war
The risks weighing on the outlook for economic activity and inflation strongly depend on the evolution of the war, and in particular its impact on the energy markets.
Given the high uncertainty, the baseline forecast is accompanied by a model-based scenario analysis that simulates the impact of higher energy commodity prices, as well as an outright reduction in gas supply from Russia. In the latter, more severe scenario, GDP growth rates would be about 2.5 and 1 percentage points below the projected baseline in 2022 and 2023, respectively, while inflation would increase by 3 percentage points. in 2022 and by more than 1 percentage point in 2023, above the baseline projection.
In addition to these potential energy supply disruptions, more serious than expected problems in supply chains and further increases in non-energy commodity prices, particularly food, could lead to downward pressures. additional growth and upward pressure on prices. Larger-than-expected second-round effects in the face of an imported inflationary shock could aggravate stagflationary forces. Strong inflationary pressures also come with heightened risks to financing conditions. Finally, COVID-19 remains a risk factor.
Beyond these immediate risks, the invasion of Ukraine by Russia leads to an economic decoupling of the EU vis-à-vis Russia, with consequences that are difficult to grasp at this stage.
College members said:
Valdis DombrovskyExecutive Vice President for an Economy that Works for People, said: “There is no doubt that the EU economy is going through a difficult period due to Russia’s war against Ukraine, and we have revised our forecast downwards accordingly. The overwhelming negative factor is soaring energy prices, which are pushing inflation to record highs and straining European businesses and households. If growth continues this year and next, it will be much more moderate than expected. Uncertainty and risks to the outlook will remain high as long as Russian aggression continues. But there are positive points that allow us to get through this crisis. Our economic fundamentals are solid: before the start of this war, the EU economy was on the path to strong recovery and growth. More jobs are being created in the EU economy, attracting more people to the labor market and keeping unemployment low. And as Member States fully implement their recovery and resilience plans, this will provide a much-needed boost to our economic strength.”
Paulo Gentilonithe economy commissioner said: “Russia’s invasion of Ukraine is causing untold suffering and destruction, but is also weighing on Europe’s economic recovery. The war has caused energy prices to soar and further disrupted supply chains, so inflation is now expected to stay higher for longer. Last year’s strong economic recovery will have a persistent positive effect on growth rates this year. A strong labor market, post-pandemic reopening and NextGenerationEU should provide further support to our economies and help reduce public debt and deficits. However, this forecast is subject to high uncertainty and risks closely linked to the development of the Russian war. Other scenarios are possible in which growth could be weaker and inflation higher than what we expect today.
This forecast is based on a set of technical assumptions regarding exchange rates, interest rates and commodity prices with a cut-off date of April 29. For all other incoming data, including government policy assumptions, this forecast considers information up to and including April 29. Unless new policies are 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 Summer 2022 Economic Forecast will update GDP and inflation projections and is expected to be presented in July 2022.