Autumn 2018 Economic Forecast: sustained but less dynamic growth amid high uncertainty

Last year’s exceptionally benign global situation helped to underpin strong economic activity and investment in the EU and euro area. Despite a more uncertain environment, all Member States are forecast to continue growing, though at a slower pace, thanks to the strength of domestic consumption and investment. Barring major shocks, Europe should be able to sustain above-potential economic growth, robust job creation and falling unemployment. However, this baseline scenario is subject to a growing number of interconnected downside risks. Valdis Dombrovskis, Vice-President for the Euro and Social Dialogue, also in charge of Financial Stability, Financial Services and Capital Markets Union, said: “All EU economies are set to grow this year and next, which will bring more jobs. However, uncertainty and risks, both external and internal, are on the rise and start to take a toll on the pace of economic activity. We need to stay vigilant and work harder to reinforce the resilience of our economies. At EU level, it means taking concrete decisions on further strengthening our Economic and Monetary Union. At national level, there is even a stronger case for building up fiscal buffers and reducing debt while making sure that the benefits of growth are also felt by the most vulnerable members of society.” Pierre Moscovici, Commissioner for Economic and Financial Affairs, Taxation and Customs, said: ‘“The European economy is holding up well, with growth easing gradually. We project this pattern will continue over the next two years, as unemployment continues to fall to levels not seen since before the crisis. Public debt in the euro area is set to continue declining, with the deficit remaining well below 1% of GDP. In an increasingly uncertain international environment, policy-makers both in Brussels and in national capitals must work to ensure that the euro area is strong enough to deal with whatever the future might hold.” Domestic demand to drive growth Rising global uncertainty, international trade tensions and higher oil prices will have a dampening effect on growth in Europe. Following years of robust employment growth, the prospect of a slowdown in labour market improvements and of increasing supply side constraints in some Member States could also add to this dampening effect. The drivers of growth are set to become increasingly domestic: private consumption should benefit from stronger wage growth and fiscal measures in some Member States. Financing conditions and high rates of capacity utilisation are also expected to remain supportive of investment. For the first time since 2007, investment is expected to increase in all Member States in 2019. Taking all of these factors into account, gross domestic product (GDP) in all Member States should continue to grow but the pace is set to slow and appears somewhat weaker than expected in the summer. Unemployment continues to fall Labour market conditions continued to improve in the first half of 2018, with employment growth remaining steady even as economic growth cooled. Job creation is set to continue to benefit from continued growth and structural reform implementation in some Member States. Unemployment should continue to fall but at a slower pace than in the past, as employment growth is eventually dampened by increasing labour shortages and slower economic growth. Unemployment in the euro area is expected to fall to 8.4% this year and then to 7.9% in 2019 and 7.5% in 2020. In the EU27, unemployment is forecast at 7.4% this year before falling to 7% in 2019 and 6.6% in 2020. This would represent the lowest unemployment rate recorded since the start of the monthly unemployment series in January 2000. Inflation driven by oil prices Headline inflation is forecast to remain moderate over the forecast period. In the euro area, inflation is set to reach 1.8% in 2018 and 2019 and to slow to 1.6% in 2020. The rise in oil prices has pushed up inflation this year and strong positive base effects are expected to continue into the first quarter of next year. While core inflation, which excludes energy and unprocessed food prices, has been relatively muted so far this year, it is expected to reassert itself as the main driver of headline inflation in 2020, as wages rise amid tightening labour markets. Public finances: debt levels are decreasing and the aggregate euro area public deficit is now below 1% The euro area’s general government deficit is projected to continue declining relative to GDP this year, thanks to lower interest expenditure. This decline is set to come to a halt next year for the first time since 2009, as the fiscal stance turns slightly expansionary in 2019 before turning broadly neutral in 2020. The euro area’s general government deficit is expected to increase from 0.6% of GDP in 2018 to 0.8% in 2019 and to decline to 0.7% in 2020. For the EU27, the general government deficit is expected to increase from 0.6% of GDP in 2018 to 0.8% in 2019 and to decline to 0.6% in 2020. Overall, the trend remains one of sizeable improvements compared to ten years ago, in 2009, where the deficit level peaked at 6.2% in the euro area, and at 6.6% in the EU. Debt-to-GDP ratios are projected to continue to fall in the euro area and in almost all Member States, supported by debt-decreasing primary surpluses and continued growth. The euro area debt-to-GDP ratio is set to fall from 86.9% in 2018 to 84.9% in 2019 and to 82.8% in 2020, down from a peak of 94.2% in 2014. In the EU27, the general government debt ratio is set to fall from 80.6% of GDP in 2018 to 78.6% in 2019 and 76.7% in 2020. Many interrelated risks and uncertainty cloud the outlook There is a high degree of uncertainty surrounding the forecast and there are many interconnected downside risks. The materialisation of any of these risks could amplify the others and magnify their impact. Overheating in the US, fuelled by pro-cyclical fiscal stimulus, could lead to interest rates rising faster than expected, which would have numerous negative spillover effects beyond the US, particularly in emerging markets which are vulnerable to changes in capital flows and exposed to US dollar-denominated debt. This could exacerbate financial market tensions. The EU could also suffer given its strong trade links and banks’ exposure. The expected widening of the US current account deficit could also stoke further trade tensions with China. This could raise the risk of a disorderly adjustment in China, given the level of corporate debt and financial fragility. Any increase in trade tensions would also hurt the EU through its effect on confidence, investment and its high integration in global value chains. Within the EU, doubts about the quality and sustainability of public finances in highly indebted Member States could spill over to domestic banking sectors, raising financial stability concerns and weighing on economic activity. Finally, risks related to the outcome of the Brexit negotiations also remain. For the United Kingdom, a purely technical assumption for 2019 and 2020 To allow for a comparison over time, the projections cover all 28 Member States, including the United Kingdom. Given the ongoing negotiations on the terms of the UK’s withdrawal from the EU, our projections are based on a purely technical assumption of status quo in terms of trading relations between the EU27 and the UK. This is for forecasting purposes only and has no bearing on the talks underway in the context of the Article 50 process. Background This forecast is based on a set of technical assumptions concerning exchange rates, interest rates and commodity prices with a cut-off date of 22 October 2018. For all other incoming data, including assumptions about government policies, this forecast takes into consideration information up until and including 22 October. Unless policies are credibly announced and specified in adequate detail, the projections assume no policy changes. The European Commission’s next forecast will be an update of GDP and inflation projections in the Winter 2019 Interim Economic Forecast in February 2019. As of this year, the European Commission has reverted to publishing two comprehensive forecasts (spring and autumn) and two interim forecasts (winter and summer) each year, instead of the three comprehensive forecasts in winter, spring and autumn that it has produced each year since 2012. The interim forecasts cover annual and quarterly GDP and inflation for the current and following year for all Member States and the euro area, as well as EU aggregates. This change is a return to the Commission’s previous pattern of forecasts and brings the Commission’s forecast schedule back into line with those of other institutions (e.g. the European Central Bank, International Monetary Fund, Organisation for Economic Co-operation and Development).