Inflation, economic slowdown... the war in Ukraine weighs on growth forecasts in Europe


Inflation, economic slowdown... the war in Ukraine weighs on growth forecasts in Europe

Inevitable. The war in Ukraine and the impact of sanctions against Russia prompted the European Commission to drastically cut its growth forecast for the European economy on Monday, due in particular to higher than expected inflation. Brussels lowered its Gross Domestic Product (GDP) growth forecast for the eurozone in 2022 by 1.3 points to 2.7% and increased its inflation forecast by 3.5 points to 6.1% , compared to the last figures announced on February 10 before the start of the Russian offensive.

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The shock is particularly harsh. This is "one of the biggest drops in forecasts" from the European Commission, said the European Commissioner for the Economy, Paolo Gentiloni, during a press conference. These figures are still subject to “high uncertainty” linked to the evolution of the conflict. “Growth could be even weaker and inflation higher.” For now, full-year growth “is not expected to be in negative territory.” But "it's a possibility" if Russia abruptly halts deliveries of Russian gas to Europe, he warned.

Across the European Union, this year's growth forecast is also lowered to 2.7% and inflation is expected even higher than in the 19 countries sharing the single currency, at 6.8%. For 2023, Brussels expects Gross Domestic Product (GDP) growth of 2.3% in the euro zone as in the EU and estimates that inflation will fall to 2.7% and 3.2% respectively.

Inflation “peak” yet to come

The war in Ukraine reinforced the headwinds that existed before the conflict began, but which should have dissipated during the year. These are in particular increases in the prices of raw materials which, beyond energy, are spreading to the prices of food and certain industrial products and services. The conflict has also increased supply chain problems and increased uncertainty for both businesses and households.

Inflation in the euro zone has hit a new record every month since November, reducing household purchasing power. It reached 7.5% over one year in April. Its “peak” is expected during the second quarter and it should then “very gradually decrease” over the rest of the year, then more markedly next year, according to Mr. Gentiloni. However, he acknowledged that possible wage increases could continue to fuel higher consumer prices, especially as the labor market remains solid. The unemployment rate is at its lowest in Europe and Brussels expects it to drop further to 6.7% this year and 6.5% in 2023 in the EU.

The economy has been on a rollercoaster ride over the past two years. After being hit in 2020 by the effects of the Covid pandemic, activity rebounded strongly from the spring of 2021. The result was record growth of 5.4% recorded last year in the euro zone, after a recession record (GDP down 6.4%) the previous year.

The debt issue

In 2022, France (3.1%) should do twice as well as Germany (1.6%), penalized both by its dependence on Russian fossil fuels and the weight of its industry, particularly the automotive industry, which is more affected by supply disruptions. Already last year, the French GDP had increased by 7% against 2.9% for that of Germany.

The European Commission globally foresees an improvement in the public accounts. In 2020, massive aid plans for the economy had propelled the deficit to 7.1% of GDP in the euro zone. Brussels is counting on 3.7% this year and 2.5% in 2023. Public debt should at the same time decline to 94.7% of GDP this year for countries sharing the single currency, then 92.7% next year. It had reached a record level of 99.2% of GDP in 2020 before returning to 97.4% last year. But the strong divergences between southern and northern Europe remain worrying.

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The Commission is due to announce next week whether it is extending the suspension of its fiscal rules into 2023 because of the war. The stability pact, which limits public deficits to 3% and debt to 60% of GDP, had been suspended until the end of 2022 because of the pandemic.