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Autumn Forecast 2013 – EU Economy: Gradual Recovery, External Risks

The EU economy has started growing again. Following a slow expansion of economic activity during the remainder of 2013, growth is set to become more robust in 2014 and 2015.

In recent months, there have been encouraging signs that an economic recovery is underway in Europe. After contracting up to the first quarter of 2013, the European economy started to grow again in the second quarter and real GDP is set to continue growing in the remainder of this year.

Growth in the second half of 2013 is expected at 0.5 % compared to the same period in 2012 in the EU. On an annual basis, real GDP growth this year is estimated at 0.0 % in the EU and -0.4 % in the euro area. Looking ahead, economic growth is forecast to gradually gather pace over the forecast horizon, to 1.4 % in the EU and 1.1 % the euro area in 2014, reaching 1.9 % and 1.7 % in 2015, respectively.

Internal and external adjustment in Europe is continuing, underpinned in many cases by the significant structural reforms and fiscal consolidation implemented in recent years. This has improved the conditions for domestic demand to gradually become the main engine of growth in Europe. However, against the background of a weakened outlook for emerging market economies, the return to solid growth will be a gradual process.

Olli Rehn, Commission Vice-President for Economic and Monetary Affairs and the Euro said: “There are increasing signs that the European economy has reached a turning point. The fiscal consolidation and structural reforms undertaken in Europe have created the basis for recovery. But it is too early to declare victory: unemployment remains at unacceptably high levels. That’s why we must continue working to modernise the European economy, for sustainable growth and job creation.”

A gradual recovery gains traction

The accumulated macroeconomic imbalances are diminishing, and growth is expected to moderately gain pace. However, the on-going balance-sheet adjustment in some countries continues to weigh on investment and consumption. While the financial market situation has improved significantly and interest rates have declined for vulnerable countries, this has not yet fed through to the real economy as fragmentation in financial markets persists, with substantial differences across Member States and across firms of different sizes.

The current outlook is in line with characteristics of previous recoveries following severe financial crises. As deleveraging needs subside, domestic demand is expected to strengthen slowly, thanks to resuming private consumption growth and the rebound in gross fixed capital formation due to improving overall financing conditions and economic sentiment. Given the progress made in recent years, the pace of fiscal consolidation is set to slow down over the forecast period. In 2014 and 2015, domestic demand is expected to be the main driver of growth, against the background of a weakened outlook for EU exports to the rest of the world.

Since labour market developments typically lag those in GDP by half a year or more, the recovery of economic activity is expected to translate only gradually into job creation. This year, unemployment has remained very high in some countries and employment has continued to decline. However, recent months have seen labour-market conditions start to stabilise and the outlook is for a modest decline in unemployment towards 10.7 % in the EU and 11.8 % in the euro area by 2015, though cross-country differences will remain very large.

Consumer-price inflation is expected to remain subdued in both the EU and euro area over the forecast period, with rates close to 1½%.

Current-account balances in vulnerable Member States have strongly and consistently improved in recent years. Following continued price competitiveness gains and a strengthening of their export sectors, a number of vulnerable Member States are expected to register current-account surpluses this year.

Early decisive effort gives way to slower speed of consolidation

The reduction in general government deficits is set to continue. In 2013, headline fiscal deficits are projected to fall to 3½% of GDP in the EU and 3% in the euro area, while debt-to-GDP ratios will reach almost 90% in the EU and 96% in the euro area. The structural budget deficit, i.e. the general government deficit corrected for cyclical factors, one-offs and other temporary measures, is forecast to decline significantly in 2013 by more than ½% of GDP in both areas, on the back of consolidation measures implemented in several Member States. According to the 2014 draft budgets that were available before the forecast cut-off date, this improvement is set to continue in 2014, but at a slower pace. This is partially explained by the fact that some Member States have already achieved their respective Medium Term Objectives for their structural budgetary balances, which should contribute to bringing the public debt onto a declining path.

Risks more balanced

This forecast is based on the assumption of rigorous implementation of agreed policy measures at EU and Member State level that will support the on-going necessary adjustment process and sustain improvements in confidence as well as financial conditions.

Due to decisive policy implementation, perceived risks to the integrity of the euro related to the sovereign debt crisis have disappeared. More upside risks have emerged, linked to the possibility that the reforms implemented in recent years could deliver further positive effects more quickly than expected. However, while uncertainty has receded, it remains elevated and threatens to remain a drag on growth. The risk remains that policy slippage could raise uncertainty and re-ignite financial stress, while downside risks in the external environment have increased.