December 7, 2022

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After a strong first half, the EU economy has now entered a much tougher phase. The shocks triggered by Russia’s war of aggression against Ukraine are weighing on global demand and adding to global inflationary pressures. The EU is among the most exposed advanced economies, due to its geographical proximity to the war and its heavy dependence on gas imports from Russia. The energy crisis is eroding household purchasing power and weighing on production. Economic sentiment has deteriorated markedly. As a result, although growth in 2022 is better than expected, the outlook for 2023 is significantly lower for growth and higher for inflation compared to the European Commission’s summer interim forecast.

Growth is expected to contract sharply at the turn of the year

Real GDP growth in the EU surprised on the upside in the first half of 2022 as consumers strongly resumed spending, particularly in services, following the easing of COVID-19 related containment measures. The expansion continued in the third quarter, but at a significantly slower pace.

In a context of high uncertainty, strong pressures on energy prices, the erosion of household purchasing power, a weaker external environment and tighter financing conditions should tip the EU, the euro area and most Member States in recession during the last quarter of the year. Nevertheless, the powerful momentum in 2021 and strong growth in the first half of the year should lift real GDP growth in 2022 as a whole to 3.3% in the EU (3.2% in the euro area) – well above of the 2.7% predicted in the preliminary summer forecast.

As inflation continues to weigh on household disposable income, the contraction in economic activity is expected to continue in the first quarter of 2023. Growth is expected to return to Europe in the spring as inflation gradually loosens its grip on the economy . However, with strong headwinds continuing to dampen demand, economic activity is expected to be subdued, with GDP growth reaching 0.3% in 2023 as a whole in both the EU and the eurozone.

By 2024, economic growth is expected to gradually pick up, averaging 1.6% in the EU and 1.5% in the euro area.

Inflation has yet to peak before gradually slowing down

Higher-than-expected inflation figures in the first ten months of 2022 and mounting price pressures should have shifted the inflation peak to the end of the year and lifted the projection for the annual inflation rate 9.3% in the EU and 8.5% in the euro zone. Inflation is expected to decline in 2023, but remain elevated at 7.0% in the EU and 6.1% in the Eurozone, before moderating in 2024 to 3.0% and 2.6% respectively.

Compared to the summer interim forecast, this represents an upward revision of almost one percentage point for 2022 and more than two points in 2023. The revisions mainly reflect wholesale gas and oil prices. significantly higher electricity prices, putting pressure on retail energy prices as well as on most goods and services in the consumer basket.

Strongest job market in decades to stay resilient

Despite the difficult environment, the labor market continued to perform well, with employment and participation at their highest level and unemployment at its lowest level in decades. Strong economic expansion has drawn two million more people into the labor market in the first half of 2022, bringing the number of people employed in the EU to a record high of 213.4 million. The unemployment rate remained at a record low of 6.0% in September.

Labor markets are expected to react to the slowdown in economic activity with some lag, but remain resilient. Employment growth in the EU is expected to reach 1.8% in 2022, before stopping in 2023 and picking up slightly to 0.4% in 2024.

Unemployment rates in the EU are expected to reach 6.2% in 2022, 6.5% in 2023 and 6.4% in 2024.

Weak growth, high inflation and energy support measures weigh on deficits

Strong nominal growth in the first three quarters of the year and the phasing out of pandemic-related support have led to a further reduction in government deficits in 2022, despite new measures adopted to mitigate the impact of soaring prices energy on households and businesses. After falling to 4.6% of GDP in 2021 (5.1% in the euro area), the EU deficit is expected to decline further to 3.4% of GDP this year (3.5% in the euro area). euro).

In 2023, however, the aggregate government deficit is expected to increase slightly again (to 3.6% in the EU and 3.7% in the euro area) as economic activity weakens, interest increases and governments extend or introduce new discretionary measures to mitigate the impact of high energy prices. Their scheduled withdrawal in 2023 and the resumption of growth should then reduce the pressure on public finances. As a result, the deficit is projected at 3.2% of GDP in the EU and 3.3% in the euro area in 2024.

Over the forecast horizon, a further reduction in the debt-to-GDP ratio is projected in the EU, from 89.4% of GDP in 2021 to 84.1% of GDP in 2024 (and from 97.1% in 91.4% in the euro area).

Exceptional degree of uncertainty

The economic outlook remains shrouded in an exceptional degree of uncertainty as Russia’s war of aggression against Ukraine continues and the potential for further economic disruption is far from exhausted.

The greatest threat comes from the unfavorable evolution of the gas market and the risk of shortages, in particular in the winter of 2023-24. Beyond gas supply, the EU remains directly and indirectly exposed to further shocks in other commodity markets that impact geopolitical tensions.

Longer-lasting inflation and possible disorderly adjustments in global financial markets to the new high interest rate environment also remain important risk factors. Both are amplified by the potential for inconsistency between fiscal and monetary policy objectives.

Background

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 31. For all other incoming data, including government policy assumptions, this forecast considers information up to and including October 27. 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 Winter 2023 Economic Forecast will update GDP and inflation projections and is expected to be presented in February 2023.