Autumn 2023 Economic Forecast: A modest recovery ahead after a challenging year

Following a robust post-pandemic expansion in 2021 and 2022, the EU economy has lost momentum. Real GDP contracted very mildly in the fourth quarter of 2022 and barely grew in the first three quarters of this year. A high cost of living took a heavier toll than expected. On the external side, global trade provided little support. Meanwhile, the response of monetary policy to high inflation is working its way through the economy, and fiscal support is partly being phased out.

This Autumn Forecast projects GDP growth in 2023 at 0.6% in both the EU and the euro area. This is 0.2 pps. lower than projected in the summer and an even larger downward revision compared to the Spring Forecast, by 0.4 pps. Going forward, growth is expected to rebound mildly as consumption recovers with rising real wages, investment remains supportive and external demand picks up.

EU GDP growth is forecast to improve to 1.3% in 2024, still below potential and a downward revision of 0.1 pps. from summer. It is projected to gain further pace, to 1.7%, in 2025.

In the euro area, GDP growth is forecast to be slightly lower, at 1.2% in 2024 and 1.6% in 2025. HICP inflation is estimated to have reached a two-year low in the euro area in October and is projected to continue declining over the forecast horizon. In the EU, headline inflation is set to decrease from 6.5% in 2023 to 3.5% in 2024 and 2.4% in 2025. In the euro area, it is forecast to fall from 5.6% in 2023 to 3.2% in 2024 and 2.2% in 2025.

The loss of growth momentum so far this year has been underpinned by the lack of a solid growth driver, with weakness especially in consumption but also on the external side. Private consumption broadly stagnated on aggregate, as nominal wage growth continued to lag behind inflation. The volume of retail sales was still declining on a year-on-year basis up to summer, notably in automotive fuels and food, where prices remain elevated. At the same time, spending on services held up, partly related to the further recovery in tourist arrivals to the EU. However, exports declined, and net trade contributed positively to growth only because the decline in imports outpaced that in exports. Investment - both public and private - also increased only marginally in the first half of the year, though its dynamics were very volatile across Member States. On the output side, gross value added in industry was held back by weak demand and high energy costs. Similarly, high input and financing costs, as well as labour shortages, dragged on construction activity, particularly in housing. With purchasing power constrained by inflation, business activity in contact-intensive services stagnated, following its fast recovery last year. By contrast, IT and business services, which account for almost one fifth of EU gross value added, enjoyed continued expansion.

The European Central Bank last hiked its policy interest rates in September, by 25 bps. Reflecting market expectations at the cut-off date of this forecast, the Euribor-3 months futures suggests that, after peaking at 4% in October, euro area short-term nominal interest rates will gradually decrease to 3% by the end of 2025. Most central banks in non-euro area Member States have also maintained their interest rates unchanged since September, while others in some Central and Eastern European countries have recently eased their monetary policy stance. In view of the path for inflation projected in this forecast, short-term real interest rates in the euro area are expected to turn positive towards year-end and increase gradually to 1% by the end of 2025. Nominal long-term rates in the euro area (10-year) increased in recent months, as investors priced in higher-for-longer policy rates. They are expected to stay at around 3.4% over the forecast horizon. In real terms, they are also projected to remain stable at around 0.9%. Meanwhile, bank lending data for the euro area show continued softening of credit flows to the private sector, with net lending flows turning even negative in a number of Member States in recent months. The decline in bank lending is due to tighter supply conditions, including through tightening credit standards for both enterprises and households, and lower demand. Tightening credit standards and lower demand are set to continue weighing on property prices, transactions and construction for a few more quarters (see Special Issue 4.1).

Total investment spending is set to grow steadily over the forecast horizon.

Strong corporate balance sheets provide room for addressing the business transformation and capacity adjustment needed for the transition to energy saving and low-emission production. Easing constraints to production are foreseen to support investment. Infrastructure investment is also set to grow, benefiting from public spending and funding from the Recovery and Resilience Facility (RRF) and cohesion policy funds. Total investment growth in the EU is expected to slow to 1.2% in 2023 and to pick up to 1.5% in 2024 and 2.3% in 2025. Overall, these rates are slower than the average of the 2015-19 period, in particular due to the decline in housing investment.

Increasing wages, continued employment growth and further slowing of inflation are expected to lift the purchasing power of households in 2024 and 2025, boosting consumption.

At the same time, after increasing this year, the saving rate is expected to remain broadly stable at a level slightly above its pre-pandemic average, hindering a stronger recovery in consumption. The higher level of interest rates increases the opportunity cost of consumption, while elevated uncertainty of consumers keeps the motivation for precautionary savings high. Furthermore, no further boost from any remaining pandemic-induced excess savings is to be expected, as these savings are increasingly allocated to less liquid assets and continue to be held by high income households with a lower propensity to consume. 

The EU labour market continued to perform strongly in the first half of 2023, despite the slowdown in economic growth. In the second quarter of this year, activity and employment rates reached their highest level on record, and in September the unemployment rate remained close to its record low.

The coexistence of low unemployment and high shares of vacancies and labour shortages points to a still tight labour market.

This tightness has been broad-based, and evidence suggests that sectoral or skills mismatches are not the main drivers. Yet, labour shortages continue to be acute in some sectors and occupations – e.g. in healthcare, hospitality, construction, and ICT (see Special Issue 4.2).. Going forward, the labour market is set to remain resilient, but there are signs of some cooling. Employment expectations as reported in the Commission´s business surveys have declined over the course of the year, while remaining well above their long-term average, and some Member States have seen an uptick in unemployment. The pace of job creation has eased in the first half of the year and is expected to remain weak in the second half. Yet as economic activity gradually improves, employment growth is set to continue. Employment growth is forecast at 1.0% in the EU this year, partly thanks to the gains recorded late last year, before easing to 0.4% in both 2024 and 2025. The unemployment rate is expected to remain broadly stable over the forecast horizon. Nominal wage growth is projected to accelerate further this year, before gradually moderating in 2024 and 2025. Importantly, this forecast sees wage growth catching up with a lag and exceeding inflation in those years, finally allowing workers to recoup purchasing power. This is still compatible with inflation coming back to target as labour productivity increases and unit profits decline.

HICP inflation has continued declining sharply from the peak of 10.6% year-on-year recorded in October 2022 in the euro area. In October this year, it is estimated to have reached a two-year low of 2.9%. Inflation in the EU has followed a similar path.

The steep decline in consumer energy prices throughout the year has been the key driver, but in recent months, moderation in inflation has been more broad-based, with several measures of underlying inflationary pressures pointing to an easing price momentum. As monetary tightening continues to work its way through the economy, inflation is set to continue declining, though at a more moderate pace, reflecting a broad-based easing of inflationary pressures in food, manufactured goods and services. Prices of services are set to decelerate more gradually than those of other consumption categories, reflecting their inherent inertia and the relatively stronger role of wages. The decline in unit profits, already observed in the first two quarters of 2023, is set to continue in 2024, accommodating the strong, although moderating, growth in labour cost (see Box I.2.2). As to energy prices, the reaction of oil prices, both spot and futures, has remained overall muted following the Hamas attack on Israel and the subsequent conflict in the Middle East. At the cut-off date of this forecast, oil price futures over the forecast horizon were only slightly higher (around 5%) than assumed in summer. The gas futures price curve remains broadly in line with the curve underpinning the Summer Forecast, with gas prices falling very gradually towards EUR 45/MWh by the end of 2025. Thus, the inflationary impulse from energy prices will be somewhat higher than previously expected in 2024 and broadly neutral in 2025.

External demand has provided little support so far this year as global goods trade continued contracting. Global growth (excluding the EU) is projected to reach 3.5% in 2023, reflecting strength in advanced economies in the first half of the year. It is forecast to inch down to 3.2% in 2024 as the effects of tight monetary policy continue weighing in and the slowdown in China continues. It is then expected to pick up again to 3.5% in 2025, as the recovery in the advanced economies takes hold. The slump in global trade continued over the summer, with global goods imports outside the EU down by 3% y-o-y in the first eight months of 2023, as geopolitical tensions and increased protectionism depressed trade elasticities. Global imports (excluding the EU) are expected to rebound in 2024 relative to the anaemic rate of 2023 and strengthen further in 2025. In line with this, EU exports are projected to pick up pace over the forecast horizon, though the EU is expected to lose market shares. However, as imports also recover in line with economic activity, the contribution of net trade to GDP growth is set to be broadly neutral in the forecast years. Meanwhile, falling energy prices have improved the EU’s terms of trade and the resulting rebound of the trade balance of goods pushed the current account balance up. The EU current account surplus is set to improve to 2.5% in 2023 and stabilise at that rate over the forecast horizon.

The EU general government deficit is projected to decline slightly further in 2023, to 3.2% of GDP, 0.1 pps. below the previous year.

Discretionary fiscal support is estimated to have decreased significantly thanks to the complete phase-out of pandemic-related temporary measures, a reduction in subsidies to private investment and a lower net budgetary impact of energy-related measures. By contrast, the less favourable economic environment and higher interest expenditure are set to provide deficit-increasing impacts to the EU aggregate deficit in 2023. Restraint in discretionary fiscal support is expected to lead to further deficit reductions in 2024 and 2025, to 2.8% of GDP in 2024 and to 2.7% in 2025. Still, higher-for-longer interest rates are set to weigh on the public finances much more than they did in the past, diverting resources from other priorities. The EU fiscal stance is projected to turn contractionary in 2023, by 0.4 % of GDP, and even more in 2024 (by 0.7%), mainly related to the expected phase-out of the energy-related measures. The no-policy-change forecast for 2025 points to a slightly contractionary EU fiscal stance that year. As a result, fiscal policies in 2023-25 are not expected to fuel additional inflationary pressures, but are also not supporting the economy. The EU debt-to-GDP ratio is set to continue to decline to 83% in 2023 due to inflation, as measured by the GDP deflator, increasing further, while higher interest rates on new debt issuances raise interest expenditure only gradually thanks to the long maturity of public debts in the EU. In 2024 and 2025, the debt ratio is projected to broadly stabilise, remaining above the 2019 level of around 79%.

Uncertainty and downside risks to the economic outlook have increased in recent months. They are primarily related to the evolution of Russia’s protracted war of aggression against Ukraine and the conflict in the Middle East. Energy markets appear most vulnerable, as renewed disruptions to energy supplies could potentially have a significant impact on energy prices, global output and the overall price level (see Box I.3.1). Economic developments in the EU’s major trading partners, China in particular, also pose risks (see Box I.2.1). On the domestic side, the transmission of monetary tightening may weigh on economic activity for longer and to a larger degree than projected in this forecast, as the adjustment of firms, households and government finances to the high interest rate environment could prove more challenging. Barring the risks to energy price developments highlighted above, risks to the inflation outlook appear broadly balanced. Finally, mounting risks associated to climate change also weigh on the outlook. Natural hazards like heatwaves, fires, droughts and floods, which have been raging across the continent with increasing frequency and scope, illustrate the dramatic consequences that climate change can have for the environment and the people affected, but also for the economy (see Special Issue 4.3).

Albania

Bosnia and Herzegovina

Moldova

Montenegro

North Macedonia

Serbia

Türkiye

Ukraine

The United Kingdom

The United States

Japan

China

EFTA

Russian Federation

Press release of 15 November 2023

EC press conference by Commissioner Paolo GENTILONI on the 2023 Autumn Economic Forecast