First, the EU economy has lost momentum since Spring.
The latest data confirm the EU economy avoided recession last winter. This is no mean feat given the magnitude of the shocks that we have faced and is a testimony to the effectiveness of our common policy response.
However, economic activity stalled in the second quarter and survey indicators point to further weakening in the coming months.
Second, headline inflation has declined further since Spring.
The decline has been driven by falling energy prices and moderating inflationary pressures from food and industrial goods.
Third, and linked to the first two messages, the forecast for growth is revised lower for this year and next while the revisions for inflation are contained.
EU GDP growth for 2023 is now estimated at 0.8%, which is 0.2 percentage points lower than projected in Spring. In 2024, the EU economy is forecast to expand by 1.4%, 0.3 percentage points below the Spring projection. For the euro area, we now project growth of 0.8% this year and 1.3% in 2024.
Also taking account of the headline inflation readings until August, this new forecast has slightly lowered the projections for inflation this year – to an average of 6.5%, from 6.7% in the Spring forecast. For 2024, the projection is at 3.2%, marginally above the spring forecast. For the euro area, we see inflation averaging 5.6% this year and 2.9% in 2023.
Fourth, the outlook remains subject to risks and uncertainty.
Uncertainty remains exceptionally high, largely due to Russia's ongoing war of aggression against Ukraine. Monetary tightening could lead to stronger adverse effects on economic activity than projected, but could also prompt a faster fall in inflation, which would accelerate the recovery of real incomes.
On economic growth: Economic activity in the EU was very subdued in the first half of 2023. EU real GDP grew by 0.2% in the first quarter and remained flat in the second. In the euro area, growth was at 0.1% in both quarters.
Stagnation of private consumption shows that high consumer prices for most goods and services have been taking a heavier toll than expected, despite declining energy prices and continued expansion of employment and rising wages. Also, the sharp slowdown in the provision of bank credit shows that monetary policy normalisation is working its way through the economy.
The weaker growth momentum is set to extend into 2024. However, a mild rebound in growth is still expected as inflation continues easing and the labour market remains robust. Following a decline of 1.1% in industrial production in the second quarter, driven by strong contractions in the production of consumer goods and energy, survey indicators indicate a further weakening of activity in the third quarter.
Moreover, both the Commission's economic sentiment indicator and the Purchasing Managers Indices (PMI) point to the weakness in industry spreading to services. The services PMI fell into contractionary territory in August.
The Commission's survey increasingly points to insufficient demand as a factor constraining business activity. Supply factors such as shortages of material and/or equipment continued to lose prominence.
On the global economy: Global growth moderated in the second quarter of 2023 after a strong beginning of the year. Growth in Q2 was driven mainly by the advanced economies while it slowed down in emerging economies, notably China.
Global PMIs indicate that services held up relatively well while weakness in manufacturing activity continued.
Overall, the outlook for global growth and trade volumes has changed only marginally. Global growth excluding the EU is now projected to reach 3.2% in both 2023 and 2024. Expansion of global trade is forecast to slow to just 1.5% in 2023 before picking up to 3.4% in 2024.
The ECB has continued normalising its main monetary policy instruments. Compared to the Spring Forecast, the increase in expected policy rates is moderate.
While the increase in the expected rates is marginal, there is growing evidence of its impact on the real economy. Financing costs have increased further and the provision of bank credit to the private sector has continued to slow, signalling an effective transmission of monetary policy.
Investments and overall activity in economic sectors most reliant on external funding are particularly affected. Notably, higher mortgage rates and overall tighter credit conditions, compounded with lower demand, continued to impact EU housing markets.
Employment continued to grow in the first half of this year while the unemployment rate declined further, reaching in July 5.9% in the EU and 6.4% in the euro area.
The labour market's reaction to the slowdown in economic growth is set to be mild. This is due to continued labour market tightness, despite some signs of cooling, and, possibly, labour hoarding due to skill shortages. A significant increase in unemployment is not expected either.
Nominal wages continued growing but still at rates slightly below inflation. As a result, the purchasing power of employees continued to decline, but more moderately than in previous quarters. Next year though, an increase in real wages is expected as inflation is set to recede, and wages rise further.
Heterogeneity across Member States remains elevated in terms of growth performance.
In Germany, GDP over the first half of the year was significantly weaker than previously expected. Declines in real wages weighed on consumption, while external demand led to subdued exports. On an annual basis, the German economy is now projected to shrink by 0.4% in 2023, a significant downward revision from the 0.2% growth projected in the Spring Forecast. In 2024, real GDP is forecast to rebound by 1.1%, driven by a recovery in consumption.
In France, economic activity rebounded strongly in the second quarter of this year, mainly driven by net exports. Domestic demand however remained sluggish. Over the forecast horizon, GDP is forecast to grow moderately as domestic demand regains some strength. Overall, economic growth is expected to reach 1.0% in 2023 and 1.2% in 2024. This compares with the Spring projections of 0.7% in 2023 and 1.4% in 2024.
In Italy, growth in the second quarter surprised on the downside with a 0.4% contraction, driven by falling domestic demand. While a slight rebound is expected in the second half of this year and next, the annual growth projections have been revised downwards since the Spring. Italian GDP is now forecast to grow by 0.9% in 2023 and 0.8% in 2024.
In Spain, the economy recorded a very strong performance in the first half of the year, exceeding our expectations. While the economic expansion is set to be more subdued in the second half of 2023, the yearly growth rate for 2023 is projected at 2.2%, 0.3 percentage points higher than in spring. In 2024, real GDP growth is forecast to moderate to 1.9%, as the softening of economic activity expected towards the end of the year extends at least into the first half of 2024.
In the Netherlands, the economy contracted in both the first and second quarters of the year on the back of declining consumer spending and contraction in exports. Annual growth in 2023 is now projected at 0.5%, a significant downward revision from the Spring Forecast. Growth is forecast to pick up slightly to 1.0% in 2024.
Finally, in Poland, the economy contracted sharply in the second quarter, by 2.2%. This was due to a negative contribution from inventories but also to subdued private consumption and weaker external demand. Growth is set to resume in the second half of 2023, bringing real GDP growth to 0.5% for this year, somewhat weaker than projected. In 2024, GDP growth is expected to reach 2.7%, unchanged from the Spring Forecast.
Inflation continued to decline over the summer months, as expected in spring. Thanks to rapidly declining energy prices, but also moderating inflation for food and industrial goods, euro area headline inflation fell to 5.3% in July – which is half of the peak registered in October 2022 It remained unchanged in August.
However, inflation in services was more persistent. It continued to trend up until July, edged down in August in the euro area and is set to moderate only gradually in the near term.
Inflation is set to continue slowing down over the forecast horizon. It should average 5.6% in 2023 and reach 2.9% in 2024 in the euro area. In the EU, it is set to decline to 6.5% in 2023 and 3.2% in 2024. The pace of decline in 2023 is somewhat faster than projected in spring, reflecting lower, on average, energy commodity prices. On the other hand, higher oil price assumptions and persistent underlying price pressures lift marginally the inflation forecast for 2024.
While inflation moderation is underway and projected to continue in all Member States, the pace of this reduction differs widely across the EU.
This year, inflation is expected to remain stubbornly high in Central and Eastern European, mostly non-euro area Member States.
Next year, inflation is set to moderate across the EU and in all six largest Member States. Central and Eastern European countries are still set to record higher inflation rates than the rest of the EU.
On risks: Russia's ongoing war of aggression against Ukraine and wider geopolitical tensions continue to pose risks and remain a source of uncertainty.
Monetary tightening could lead to stronger adverse effects on economic activity than projected, but could also prompt a faster fall in inflation, which would accelerate the recovery of real incomes.
Indeed, the evolution of inflation could surprise on both the downside and the upside. As domestic demand weakens, inflation may decline faster than projected. However, price pressures could also turn out to be more persistent. This would continue restraining households' purchasing power and force a stronger response of monetary policy, with further adverse impact on the economy. Meanwhile, the evolution of food and energy prices, assumed to be on a downward trend in this forecast, remains subject to risks.
Finally, climate risks, illustrated by the extreme weather conditions and unprecedented wildfires and floods in the summer, also weigh on the outlook.
To sum up, while we avoided a recession last winter, the multiple headwinds facing the EU economy this year have led to somewhat weaker growth momentum than we projected in the spring. Inflation is declining but its future course is subject to uncertainty for the broader economic outlook. As of course is Russia's ongoing brutal war against Ukraine.
And yet we must have trust and confidence in the future of the European economy. There is much that we can do to support sustained and sustainable growth. The effective implementation of national recovery and resilience plans remains a key priority. Prudent, investment-friendly fiscal policies should be pursued, in sync with the ongoing efforts of our central banks to tame inflation. Coordination and agility on fiscal policies would be key. Lastly, we must work with determination to conclude an agreement on the reform of our fiscal rules by the end of the year.
