Spring brought a positive growth surprise...
The EU economy is rebounding from the pandemic recession faster than expected. Households responded to the improving epidemiological situation and the gradual relaxation of containment measures with a spending spree that propelled EU private consumption growth to 3.3% q-o-q (3.5% in the euro area) in the second quarter of 2021. The rebound of economic activity was broad-based, with all components of domestic demand contributing positively to the 2.0% q-o-q rebound in GDP (2.1% in the euro area).
…and in summer the EU economy regained its pre-pandemic output level
Economic indicators suggest that growth continued unabated in the summer, also underpinned by a revival of intra-EU travel that benefited in particular EU touristic regions. The projected growth rate of 2.1% for the third quarter – corroborated by Eurostat’s preliminary flash estimate released after the cut-off date – allowed the EU as a whole to virtually close the gap with its pre-pandemic output level and move from recovery into expansion.
New headwinds to the economic outlook are mounting
The supply side of the economy struggles to keep pace with the abrupt swings in the level and composition of global demand. This affects several key industries, including global logistics and the production of raw materials and microprocessors. Sporadic localised pandemic-related lockdowns together with emerging labour shortages add to the disruptions.
… and surging energy prices weigh on consumption and investment
Surging energy prices, most notably for natural gas and electricity, are also expected to dampen the growth momentum in the short term. After falling sharply in 2020, energy prices have increased at a tumultuous pace over the last month and are now above pre-pandemic levels. High wholesale energy prices are making their way to retail prices for households and producers, though at a varying degree and pace across countries, with potential knock on effects on consumption and business investment.
Growth in the EU is expected at 5%, 4.3% and 2.5% in 2021, 2022 and 2023, respectively.
Despite these mounting headwinds, the EU is projected to keep expanding over the remainder of the year, achieving a growth rate of 5.0% for 2021 as a whole (as in the euro area), 0.2 pps. higher than expected in the previous forecast in the summer. In 2022, the propelling forces of the re-opening are set to fade out, while supply bottlenecks loosen and energy prices abate. Growth is expected to be supported by an improving labour market, still high savings, favourable financing conditions and the full deployment of the Recovery and Resilience Fund (RRF). Economic activity in the EU is thus projected to expand by a solid 4.3% (same as in the euro area) in 2022, before decelerating to 2.5% (2.4% in the euro area) in 2023. Importantly, although the pace of growth is projected to remain uneven across countries and sectors, the EU is set to return onto its path of economic convergence. By early 2023, moreover, real GDP is expected to converge to the steady growth path that the economy was set to follow before the pandemic.
Labour market conditions are improving…
Labour market conditions also improved markedly in the second quarter, with the creation of about 1.5 million jobs and a swift rebound in hours worked, also as many workers exited job retention schemes. Yet, employment in the EU remained shy of its pre-pandemic level, and the amount of labour market slack had not yet been fully re-absorbed, on account of a still high number of unemployed people and inactive people who are available to work but not actively seeking.
… and pockets of labour shortages are emerging
Since then, however, unemployment has declined further. At 6.8% of the labour force, the EU unemployment rate in August stood just above the rate recorded at the end of 2019. Data released after the cut-off date of the forecast reveal that it declined slightly further in September. What is more, pockets of labour market shortages are emerging, particularly in sectors where activity is surging most.
The labour market completes its recovery in 2022
As the economy expands, the labour market is forecast to complete its recovery next year. An estimated 3.4 million jobs are projected to be created in 2022 and 2023, bringing the unemployment rate in the EU down to 6.5% in 2023. RRF-financed investments and accompanying structural reforms are expected to push productivity growth to a strong pace of 2.9% next year and 1.6% in 2023.
EU current account surplus expected to rise as the pandemic shock wanes
The EU current account surplus is projected to increase over the forecast horizon, from 2.7% in 2020 to 3.2% in 2023, above the pre-pandemic level of 3.0%. This largely reflects the waning of the disruptions generated by the COVID-19 shock. In particular, the current account balance is expected to be driven higher by the rise in the services trade surplus, mainly on the back of the recovery in international tourism. The merchandise trade surplus is set to decline over 2021-2022, also due to a high energy bill. In 2023, positive terms of trade developments and an improving export performance will raise the goods trade balance. Additionally, the narrowing of the joint deficit of current income and transfers adds to the projected widening of the current account surplus over the forecast horizon.
Global economy to expand robustly amid rising divergences
Following a collapse by 2.9% in 2020, the global economy (excl. EU) is projected to recover by a strong 5.8% in 2021, amid a rebound in goods trade and the reopening of domestic services. Global real GDP growth is forecast to moderate to 4.5% and 3.7% in 2022 and 2023, respectively, as the cyclical recovery gradually peters out and supportive macroeconomic policies are scaled back in many countries. This aggregate picture, however, masks a differentiated picture both between and across advanced and emerging market economies, also reflecting differences in the pace of vaccination rollout. In China, economic activity is set to slow down amid an excessively leveraged corporate sector, weaker infrastructure investments and a tightening of the regulatory framework.
Inflation in the euro area is set to peak in the fourth quarter of this year…
Following several years of low inflation, the strong resumption of economic activity has been accompanied by a pick-up in inflationary pressures, which exceeded expectations. Annual HICP inflation in the euro area hit a ten-year high of 3.4% in September, and Eurostat’s flash estimate for October, released after the cut-off date of the forecast, stood even higher, at 4.1%. This swift increase reflects to a large extent strong base effects, as factors that dragged down prices during the pandemic in 2020 are ceasing to play a role this year. In recent months, increases in energy prices well above the pre-pandemic levels have fuelled new inflationary pressures and price increases have become broad-based, also under the impact of supply disruptions. As a result, core inflation (headline inflation excluding energy and unprocessed food) reached 1.9% in September (flash estimate of 2.1% in October), the highest rate since 2012. Inflation in the euro area is set to peak at 3.7% in the last quarter of the year and continue recording high prints in the first half of 2022.
… and decline over the course of 2022 before stabilising in 2023
Being to a large extent linked to the post-pandemic re-opening and ensuing economic adjustment, the current elevated price pressures are still expected to be largely transitory. After reaching 2.4% in 2021, inflation in the euro area is forecast to decline to 2.2% in 2022 and 1.4% in 2023, as energy prices are set to gradually level out as from the second half of next year and the imbalances between supply and demand solve. In the EU, inflation is expected to be a notch higher, at 2.6% in 2021, 2.5% in 2022 and 1.6% in 2023.
Large government deficits declining in 2022 and 2023
The EU aggregate general government deficit is forecast to narrow only marginally in 2021, to 6.6% of GDP, on the back of the still high level of support provided to households and firms. As the economy moves from recovery to expansion, the unwinding of the emergency support measures and the rebound in revenues are forecast to roughly halve the aggregate budget deficit to around 3.6 % of GDP in 2022, and to reduce it further to 2.3% in 2023. However, nationally-financed current expenditure is expected to increase in 2022, signalling that governments have increased expenditurenover and above the temporary emergency support deployed to tackle the COVID-19 crisis. After reaching around 92% in the EU (99% in the euro area), the aggregate debt-to-GDP ratio is projected to broadly stabilise this year, and start declining in 2022, reaching 89% of GDP in 2023 (97% in the euro area).
The recent surge in COVID-19 infections tilts the balance of risks to the downside...
Although the impact of the pandemic on economic activity has weakened considerably, COVID-19 has not yet been defeated and the recovery is heavily dependent on its evolution, both within and outside the EU. The recent surge of cases in many countries may lead to the reintroduction of restrictions with impact on economic activity. In the EU, this risk is particularly relevant in Member States with relatively low vaccination rates.
.. and uncertainty and risks surrounding the forecast remain high.
As suggested by the new Commission’s survey-based measure, in September uncertainty was significantly lower than the peak achieved during the first wave of infections, but remained above pre-pandemic levels. Besides the risks around the evolution of the pandemic, economic risks also relate to the potential protracted impact of the current supply constraints and bottlenecks. The main upside risk to the growth outlook is related to potential strong efficiency gains and durable productivity advances triggered by the pandemic-induced structural changes. Investments fostered by the RRF and the accompanying structural reforms will be instrumental in this respect. Inflation may turn out higher than forecast if supply constraints are more persistent and above-productivity wage increases are passed on to consumer prices.