Let me begin with the five key messages emerging from this forecast:
First, compared to our Winter Forecast, published two weeks before Russia's invasion of Ukraine, growth in the EU economy is revised lower, and inflation higher.
We now forecast the EU economy to grow by 2.7% this year before slowing further to 2.3% in 2023. For 2022, this is 1.3 percentage points lower than projected in February, one of the steepest downgrades between forecasts of recent years. Annual inflation is expected to hit an all-time high of 6.8% this year, and to fall to 3.2% in 2023.
Second, the war has clearly exacerbated the headwinds that were previously expected to gradually fade. These include the sharp rise in commodity prices and the aggravation of existing supply-side disruptions, as well as the emergence of new ones, for instance in transport and logistics.
Third, a strong and improving labour market, decreasing household saving rates, favourable financing conditions and the full deployment of the Recovery and Resilience Facility are set to support the economy.
Fourth, government deficits and debt ratios are forecast to decline this year and next. Governments are in the process of phasing out the COVID-19 emergency support measures and the cyclical rebound in revenues is in full swing.
- The aggregate budget deficit in the EU should decline from 4.7% in 2021 to 2.5% in 2023.
- The aggregate debt-to-GDP ratio is projected to continue on the downward trend, falling from 7% in the EU in 2021 (97.4% in the euro area) to 85.2% in 2023 (92.7% in the euro area).
And fifth, uncertainty around the outlook has clearly increased and risks have tilted to the downside and are predominantly related to the duration of the war. Given the unprecedented nature and size of the shocks affecting the EU economy, our forecast baseline is underpinned by several technical assumptions.
- First, the extremely elevated geopolitical tensions are not expected to normalise before the end of the forecast horizon – these are our assumptions;
- No major disruptions to the supply of energy commodities to the EU economy occur in the forecast horizon – again, this is the assumption (in line with the customary no-policy change assumption, as by the end of April which was the cut-off date of the forecast no such disruptions were observed).
Recognising elevated risks around this baseline, the forecast is accompanied by a model-based scenario analysis that simulates the impact of higher energy commodity prices as well as of an outright cut in gas supply from Russia. And I will come back to these model scenarios at the end.
Real growth projections for the EU this year and next have been revised down under the heavy impact of Russia's invasion of Ukraine. Still, the European economy is expected to continue expanding as residual support from the post-pandemic re-opening and the strong policy response to the COVID-19 shock still support growth.
I am conscious that the growth projection for this year, 2.7%, may appear benign relative to the size of the shock generated by the war. However, out of this figure, as much as 2 pps is due to the exceptionally strong rebound of last year. Net of this so-called “carry-over effect”, within-year growth for 2022 has been cut from 2.1% to 0.8%.
In both 2022 and 2023, domestic demand is expected to keep driving growth. In particular, private consumption and investment are set to continue growing, albeit at a weaker pace than previously expected.
Both private consumption and investment are expected to be negatively affected by high inflation, uncertainty, and aggravated supply bottlenecks. At the same time, consumption should continue benefitting from the post-pandemic reopening momentum, a buoyant labour market, lower accumulation of savings and fiscal measures to offset rising energy. Investment is set to be supported by the full deployment of the RRF and the implementation of the accompanying reforms.
Finally, net exports are projected to provide only a marginal positive contribution to growth, as both export and import volumes slow down.
Inflation has been picking up momentum since early 2021. In the euro area, it rose from 4.6% year-on-year in the last quarter of 2021 to 6.1% in the first quarter of 2022, and then further up to 7.5% in April. This is the highest rate in the history of our monetary union.
This acceleration has been driven by the surge in commodity prices that lifted energy and food price inflation to multi-year highs. At the same time, inflationary pressures are broadening to other categories of goods and services. And this is well visible in the continued rise in core inflation, which eliminates energy and unprocessed foods.
Inflation is expected to peak at 6.9% in the euro area in the second quarter of this year, and gradually decline thereafter, largely reflecting the commodity price assumptions, which are derived from market futures. On an annual basis, inflation in the euro area is projected to reach 6.1% in 2022, before falling to 2.7% in 2023.
Core inflation is forecast to be above 3% in both 2022 and 2023, though falling gradually in 2023.
Recent inflation readings and the inflation outlook for the next two years differ widely across Member States. In 2022 inflation is expected to range from 4.4% in Portugal to 12.5% in Lithuania, with four Member States with inflation below 5% and five above 10%. In 2023 the range is expected to narrow considerably to between 1.8% (Spain) and 7.1% (Poland). Inflation expected in Central and Eastern Europe is visibly higher than in the rest of the EU.
Inflation differentials largely reflect dispersion in retail energy price developments, as well as the importance of energy and food in national consumer baskets.
The main hit to the EU economy comes through commodity markets, primarily surging prices of energy, but also food commodities. Sharply rising commodity prices are depressing household purchasing power and rising production costs for firms, while fuelling inflation.
The war is also weighing heavily on global activity and trade, reducing external demand for EU exports. First, directly, via the fall in trade with the region at war, but also through a major terms-of-trade shock, and exacerbating shortages and various supply-side bottlenecks.
Financial markets are also an important channel of impact. The war triggered a repricing of financial assets, tightening of financing conditions and increased prospects of accelerated normalisation of monetary policy.
Finally, the war has dramatically raised uncertainty and severely dented household and business confidence just as most of the EU was shaking off the pandemic blow.
Supply uncertainty in the aftermath of the war has brought renewed upward pressures on commodity prices. The increase was broad-based and affected metals, agricultural commodities, but predominantly fossil fuels – gas and oil.
Higher energy and food prices reduce households' purchasing power, especially for lower-income families. This weighs on consumption and dampens domestic demand.
They also increase production input costs, raising producer price inflation across the economy. In the case of energy-intensive industries, this may lead to serious disruptions in the production process and result in shortages in certain markets.
It is important to stress that the forecast uses the indications coming from markets' futures curves to project developments of commodity prices and does not factor in large-scale interruptions in their supply.
The shockwaves of the Russian invasion of Ukraine are reverberating globally. The direct impact is related to the collapse of activity and trade across the Eastern neighbourhood of the EU. Indirectly, negative spillovers to global demand come from the surge in commodity prices, disruptions in the supply of raw materials and intermediate inputs, aggravated transport bottlenecks and tightening financing conditions.
Lockdowns in parts of China further weaken the outlook for emerging Asia, with global ramifications through amplified disruptions to logistics and value chains.
Reflecting these headwinds, the growth forecast for the global economy in 2022 has been downgraded by 1.3 percentage points compared to the Autumn Forecast. So global GDP is now expected to expand by 3.2% in 2022 before picking up to 3.5% in 2023.
Global trade has been revised down even more. Following a very strong rebound in 2021, the volume of global imports of goods and services is now forecast to grow by 4.9% and 4.4% in 2022 and 2023, respectively. This is 1.5 percentage points lower than in the Autumn for this year.
The labour market entered 2022 on a strong footing. The EU economy last year created more than 5.2 million jobs and attracted nearly 3.5 million more people into the labour market. In addition, unemployment at the end of 2021 fell below previous record lows.
Employment in the EU is projected to grow by 1.2% this year, though here, too, the annual growth rate is lifted by the strong momentum in the second half of last year. People fleeing the war in Ukraine to the EU are expected to enter labour markets only gradually, with tangible effects only from next year.
Unemployment rates are forecast to decline further, to 6.7% this year and 6.5% in 2023 in the EU. In the euro area, unemployment is projected at 7.3% in 2022 and 7.0% in 2023.
This good employment news is tempered by the fact that in 2022, purchasing power is set to decline in real terms, as wages are not projected to keep up with inflation.
An additional tailwind to growth will come from the decline in the household savings rate. Following a large accumulation of savings during the pandemic, households are now expected to devote more of their disposable income to consumption.
Public investment is expected to increase over the forecast horizon, driven by EU funds and in particular by the Recovery and Resilience facility.
Beyond public investment, RRF grants are largely used to cover capital transfers and current expenditures. The total projected absorption up to the end of 2023 amounts to some 1.3% of EU GDP.
All EU economies are expected to continue growing over the forecast horizon. Following the uneven rebound from the COVID-19 crisis, the effects of the war in Ukraine have extended the list of factors explaining uneven growth outcomes. Seven Member States, including Germany, Spain and Italy, had not reached their pre-pandemic output level by the end of last year.
A few words now on the largest EU economies.
The fallout of the war in Ukraine and COVID-19-related lockdowns in some of China's industrial hubs are hampering economic activity in Germany. Following subdued growth at the beginning of this year, Germany's GDP is expected to slightly contract in the second quarter. The German economy is expected to return to growth in the third quarter. Overall, real GDP is projected to grow by 1.6% this year and by 2.4% the next.
In France, following stagnation in the first quarter, GDP is expected to increase in the second. Services are set to benefit from the full easing of sanitary restrictions while industry shows signs of resilience. Real GDP in France is forecast to grow by 3.1% in 2022 and by 1.8% in 2023.
For Italy, the short-term outlook remains subdued, as the war has dented economic sentiment and exacerbated existing obstacles to growth. Still, real GDP is projected to increase by 2.4% this year. Next year, growth is forecast at 1.9% in 2023, supported by RRF-financed investment.
Spain is forecast to maintain strong growth this year, although the momentum should ease markedly in the second quarter. RRF investments and the recovery of tourism are set to support growth. Real GDP is projected to grow by 4% in 2022 before easing to 3.4% in 2023.
Lastly, Poland entered 2022 on a strong economic footing. A fall in sentiment, a collapse in trade with Russia and Ukraine, and increased inflation weighing on purchasing power are set to decelerate growth in the short term. Overall, the economy is forecast to grow by 3.7% in 2022 and 3% in 2023.
The general government deficit in the EU is forecast to fall from 4.7% of GDP in 2021 to 3.6% in 2022 and further down to 2.5% in 2023. This trend reflects the unwinding of fiscal measures taken in response to COVID-19 and improvements in the cyclical components of the budget.
The number of countries with a deficit exceeding 3% of GDP fell to 15 in 2021. Under the no-policy change scenario, it is projected to rise to 17 in 2022, before falling back to 11 in 2023.
The additional costs in 2022 related to measures to mitigate the impact of high energy prices (0.6% of GDP for the EU) and to deal with the humanitarian crisis provoked by Russia (0.1% of GDP) are not – at the moment – enough to outweigh these factors. At the moment we factor in what was decided until the end of April.
Overall, these developments imply a supportive stance in 2022, followed by normalisation in 2023.
The debt-to-GDP ratio for the EU as a whole is set to decline from 89.7% of GDP in 2021 to 85.2%in 2023.
Risks related to the unpredictable evolution of the war and of energy markets dominate the risk balance. This motivates the model-based scenario analysis that I will discuss in the next slide.
Strong inflationary pressures also come with increased risks to financing conditions, in the EU and globally. This includes a stronger-than-currently-expected rise in interest rates that could trigger a correction in the valuation of financial and non-financial (e.g. housing) assets, burden the banking sector and reduce the availability of credit. These are risks. The unwinding debt crisis in China's real estate sector continues to pose domestic risks with large negative spillovers to the rest of the world.
A resurgence of the pandemic in Europe and outside also cannot be ruled out. This could cause new disruptions to the EU economy.
On the positive side, domestic demand could prove more resilient to increasing prices if households were to use more of their savings for consumption. Furthermore, investments fostered by the RRF could generate a stronger impulse to activity.
As mentioned earlier, our baseline forecast is accompanied by a model-based scenario analysis that simulates the impact of higher energy commodity prices – this is the adverse scenario – as well as of an outright cut in gas supply from Russia – this is the severe scenario.
In this latter, more severe scenario, GDP growth rates would be around 2.5 and 1 percentage point below the forecast baseline in 2022 and 2023, respectively, while inflation would increase by 3 percentage points in 2022 and more than 1 in 2023 above the baseline projection.
Under both of these scenarios, within-year growth would be in negative territory.
To conclude, Russia's unprovoked invasion of Ukraine is causing untold suffering and destruction, but is also weighing on Europe's economic recovery.
Last year's strong economic rebound will have a lingering positive effect on growth rates this year. But this should not detract from the impact that the war is having on our economies – even if the strong policy response deployed during the pandemic has boosted our resilience.
Our forecast is subject to very high uncertainty and risks, and other scenarios are possible under which growth may be lower and inflation higher than we are projecting today. In any case, our economy is still in a far from normal situation.
And now I am looking forward to taking your questions.
- Publication date
- 16 May 2022
- Representation in Cyprus