The EU economy has taken a beating from the war in Ukraine, forcing the European Commission to issue one of its largest-ever growth downgrades Monday. But don’t call it the S-word.
While growth in the bloc is going to stay positive at 2.7 percent this year, it would only be a meagre 0.8 percent if stripped of strong rebound effects carried over from 2021, the EU executive said. Germany, the bloc’s economic engine, is expected to grow by only 1.6 percent this year, slowed down by the ripple effects of Chinese lockdowns.
At the same time, eurozone inflation is expected to reach 6.8 percent this year, peaking at 6.9 percent this quarter before gradually slowing down to 2.7 percent in 2023.
“We have very high level of inflation, and we have one of the deepest downward [revisions] for growth in our seasonal forecast. But this is not until now bringing growth in negative territory,” said Commissioner Paolo Gentiloni. “Of course this is possible if the negative scenarios materialize, but this is not our base forecast.”
But he brushed away talk of stagflation, a term coined in the 1970s to describe the toxic mix of high inflation, slow growth and high unemployment. While the EU is struggling on the first two fronts, unemployment has sunk to record lows and is expected to shrink even further to 6.7 percent this year and 6.5 percent the next.
“I’m not a strong supporter of the stagflation word because it was used in previous and very different circumstances, but indeed we have very high inflation and quite low growth,” Gentiloni said.
Under adverse scenarios of even-higher energy prices or a halt to Russian gas, growth would grind to a halt and enter negative territory for the most of this year, with the worst hit being countries with high dependence on Russian gas imports like Germany and Italy.
If oil and gas prices surge by a quarter of their baseline value, the bloc would face fewer exports, as well as further supply chain disruptions and increased import prices. “Each of the two factors shaves off around 0.5 percentage points of GDP growth in 2022,” the Commission wrote.
If gas supplies were halted, the EU economy could lose up to 2.5 percentage points of growth this year, and send inflation above 9 percent this year, with gas-reliant countries doomed for a recession.
The downbeat forecast calls on countries to keep supporting their economies this year, before “normalizing” fiscal policy the next, Gentiloni said. The EU will announce next week whether it will grant an extension to the suspension of fiscal rules, due to expire this year — a decision that’s expected to be in the cards.
“There is a loss of purchasing power. We should try to cushion this especially for more vulnerable workers and households. And we should not forget the fact that this is probably not there to last forever,” he said.
To rein in inflation expectations, the European Central Bank is likely to announce in July a hike in its policy rate, which is currently at minus 0.5 percent, as signalled by President Christine Lagarde, and end the year in positive territory with a further two hikes.
“We obviously see a risk event if growth were to slip, the hiking cycle could be delayed although the emphasis on price stability by ECB communication puts a high hurdle for such delay,” said Filippo Taddei, chief economist for Southern Europe at Goldman Sachs.
This story has been updated.
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