by Keith Zahra
LONG-DRAWN WAR DRIVES ENERGY PRICES, INFLATION TO RECORD-LEVEL
2022 was supposed to be the year of the great recovery after two years of social restrictions resulting from a pandemic which brought economies to a halt. As the long-drawn war in Ukraine approaches the colder months, the economic implications of the war and the sanctions on Russia for the global economy have turned gloomier. The shocks unleashed by the war are hitting the EU economy both directly and indirectly, setting it on a path of lower growth and higher inflation. Families and businesses around the globe are pushing global inflationary pressures, eroding the purchasing power of households and pushing central banks to increase interest rates. All this has greatly increased the probability of slow economic growth coupled with inflation: the much dreaded stagflation.
GDP GROWTH TO STALL
According to the European Commission’s latest forecast, real GDP is forecast to grow by 2.7% in 2022 and 1.5% in 2023 in the EU and by 2.6% in 2022 and 1.4% in 2023 in the euro area. The positive figure however should be considered in the context of the momentum gathered with the recovery of last year and a stronger first quarter than previously estimated. Both bring acquired growth in the first quarter of this year to a solid 2.7% for the EU and 2.4% for the euro area. Economic activity weakened in the second quarter but seemed to regain some traction during summer, thanks to a promising tourism season. In 2023, economic growth is expected to gather some momentum, on the back of a resilient labour market, moderating inflation, support from the massive inflow of funds originating from the Recovery and Resilience Facility and a still large amount of excess savings. However, on an annual basis, there is a downward revision of almost one percentage point compared to the Spring Forecast.
At the same time, survey indicators, such as the EU-wide Purchasing Managers’ Index, point to a contraction in both the manufacturing and services sectors throughout Summer. According to the European Central Bank, the negative shock to real disposable income owing to rising prices is also expected to weigh on activity. Uncertainty, in particular related to gas supply disruptions, together with sharp increases in bank lending rates, is also constraining economic activity.
In August 2022, the Economic Sentiment Indicator (ESI) decreased further in both the EU (-1.0 point to 96.5) and the euro area (-1.3 points to 97.6). In the EU, the ESI’s decrease in August was driven by a significant weakening of confidence in the industry and, to a lesser extent, services, which was only partially offset by tentative signs of stabilisation of retail trade, construction and consumer confidence. Amongst the largest EU economies, the ESI collapsed in the Netherlands (-4.8) and posted significant declines in Germany (-2.5), France and Poland (both -1.8), as well as Italy (-1.2).
On the other hand, according to an EU-wide Business and consumer survey, consumer confidence showed signs of stabilisation (+1.0) after ten months of declining readings. After sinking to new all-time lows in July, households’ assessments of their past financial situation stayed virtually unchanged and the outlook on their future financial situation even improved. Consumers’ expectations about the general economic situation edged up and their intentions to make major purchases stayed practically unaltered. Retail trade confidence remained broadly flat (+0.3).
In the euro area in June 2022, compared with June 2021, the volume of retail trade decreased by 4.8% for non-food products and by 3.1% for food, drinks and tobacco, while it grew by 2.0% for automotive fuels. In the EU, the retail trade volume decreased by 3.9% for non-food products and by 2.3% for food, drinks and tobacco, while it grew by 2.7% for automotive fuels. Among Member States for which data is available, the largest yearly decreases in the total retail trade volume were registered in Denmark (-9.5%), Germany and Ireland (both -8.8%) and the Netherlands (-6.1%). The highest increases were observed in Slovenia (+22.1%), Poland (+9.3%) and Cyprus (+8.4%).
EMPLOYMENT WITHSTANDS CRISIS
Despite international turbulence, the employment market remains relatively strong. In July 2022, the euro area seasonally-adjusted unemployment rate was 6.6%, down from 6.7% in June 2022 and from 7.7% in July 2021. The EU unemployment rate was 6.0% in July 2022, down from 6.1% in June 2022 and from 6.9% in July 2021.
Eurostat estimates that 12.959 million men and women in the EU, of whom 10.983 million in the euro area, were unemployed in July 2022. Compared with June 2022, the number of persons unemployed decreased by 113,000 in the EU and by 77,000 in the euro area. Compared with July 2021, unemployment decreased by 1.8 million in the EU and by 1.58 million in the euro area.
In July 2022, 2.63 million young persons (under 25) were unemployed in the EU, of whom 2.17 million were in the euro area. In July 2022, the youth unemployment rate was 14.0% in the EU and 14.2% in the euro area, down from 14.2% and 14.4% respectively. Compared with June 2022, youth unemployment decreased by 55,000 in the EU and by 35,000 in the euro area. Compared with July 2021, youth unemployment decreased by 329,000 in the EU and by 244,000 in the euro area.
COST-OF-LIVING THE BIGGEST CHALLENGE
Families and businesses across the continent are struggling with record price increases. Euro area annual inflation reached 9.1% in August 2022, up from 8.9% in July. Expectedly, energy had the biggest contribution to this (38.3%, compared with 39.6% in July), followed by food, alcohol & tobacco (10.6%, compared with 9.8% in July), non-energy industrial goods (5.0%, compared with 4.5% in July) and services (3.8%, compared with 3.7% in July).
For the last month for which data is available on a country-by-country basis (July), the lowest annual rates were registered in France, Malta (both 6.8%) and Finland (8.0%). The highest annual rates were recorded in Estonia (23.2%), Latvia (21.3%) and Lithuania (20.9%). Compared with June, annual inflation fell in six Member States, remained stable in three and rose in eighteen.
Inflation in the EU is expected to average to 8.3% in 2022 (7.6% in the euro area), and to 4.6% in 2023 (4.3% in the euro area).
GOVERNMENT BUDGETS TAKE A BATTERING
The prevailing situation is also impacting Member States’ budgets. The euro area budget balance is projected to improve steadily in the period to 2024, but by less than foreseen in the June 2022 projections. At the end of the first quarter of 2022, the government debt to GDP ratio in the euro area stood at 95.6%, compared with 95.7% at the end of the fourth quarter of 2021. In the EU, the ratio also decreased from 88.1% to 87.8%
The highest ratios of government debt to GDP at the end of the first quarter of 2022 were recorded in Greece (189.3%), Italy (152.6%), Portugal (127.0%), Spain (117.7%), France (114.4%), Belgium (107.9%) and Cyprus (104.9%), and the lowest in Estonia (17.6%), Luxembourg (22.3%) and Bulgaria (22.9%).
Future hard to predict The uncertainty surrounding the developments in Ukraine makes forecasting harder. In its Summer assessment, the European Commission acknowledges that risks to the forecast for economic activity and inflation are heavily dependent on the evolution of the war and in particular its implications for gas supply to Europe.
The possibility that the resurging pandemic in the EU brings renewed disruptions to the economy cannot be excluded. According to the European Central Bank, high inflation will imply a contraction in real disposable income in both 2022 and 2023, despite the continued resilience of the labour market and associated labour income. While the labour market is projected to weaken in the wake of the expected slowdown in economic activity, it is seen to remain resilient overall.
New increases in gas prices could further drive-up inflation and stifle growth. Indeed, discussions in Brussels on the issue were complex and long-drawn. The European Commission has pushed a package of proposed emergency measures this week including a windfall profit levy on energy firms, but countries are split over the details and whether to impose a cap on gas prices.
Second round effects could in turn amplify inflationary forces and lead to a sharper tightening of financial conditions that would not only weigh on growth but also come with increased risks for financial stability. Despite all this, the EU economy is set to continue expanding, but at a significantly slower pace than expected earlier this year.
Key sources: Eurostat data, European Commission Spring & Autumn Economic Forecasts, European Central Bank Macroeconomic projections September 2022
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