As global growth slows sharply and with the financial crisis having escalated, economic growth grinds almost to a standstill
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On 3 November 2008 the European Commission published its autumn economic forecasts, updating the outlook for the period 2008-2010 for the EU and Euro area aggregates. In short, the economy is expected to come to a virtual stand-still in both the EU and the euro area in 2009. This forms a significant downward revision compared with the Commission´s spring forecast. This downturn will, on the other hand, help ease inflationary pressures as oil prices come down and the risks of second-round effects diminish. But both labour markets and public finances are set to deteriorate. This forecast is surrounded by considerable uncertainty at the current juncture and downside risks prevail.
Growth in the EU falls sharply
With the financial crises having deepened and broadened in the past weeks, the Commission’s economic forecast projects economic growth to drop sharply. The outlook for the EU economy remains bleak further ahead, with several of the EU economies in or close to a recession. According to the autumn forecast, GDP growth will slow down to 1.4% in 2008 (half what it was in 2007), 0.2% in 2009 and 1.1% in 2010 in the EU (1.2%, 0.1% and 0.9%, respectively, for the euro area). This cuts the spring forecast figure by half a percentage point (pp.) for this year and around 1½ pps. for 2009. More broadly, also global growth is forecast to slow markedly, especially among advanced economies.
Inflation pressures easing
Consumer price inflation is expected to have peaked and is set to fall rapidly to about 2¼% in 2009 and to about 2% in 2010 in both the EU and the euro area. The recent strong decline in commodity prices, together with a marked weakening of the growth outlook and a related easing of the labour-market situation, reduces considerably the risk of second-round effects and put wages on a decelerating path ahead.
Labour markets feel the pain
The moderation in growth has started to affect the labour market, and the outlook is for a fall in employment next year in both the EU and the euro area. Further ahead, a slight improvement in employment growth is on the cards for most Member States as economic activity picks up. Employment is thus expected to increase by about ¼ million jobs in the EU and ½ million in the euro area in 2009-2010, markedly less than the 6 million new jobs created in 2007-2008 in the EU (4 million of which were in the euro area). As a result, the unemployment rate is expected to increase by about 1 pp. in the coming two years. This would correspond to an unemployment rate of 7.8% in the EU and 8.4% in the euro area in 2009, with a further increase projected for 2010.
Public finances will be hit as well
The worse economic outlook is expected to take a toll on public finances as well, with the deficit in the general government balances increasing from less than 1% of GDP in 2007 in the EU to 2.6% in 2010 (based on the usual no-policy-change assumption). For the euro area, the deficit is expected to rise to 1.3% this year and 2% in 2010. Most countries will be affected, although with significant differences. The outlook for public finances is particularly unsure due to uncertainties over the fiscal implications of government rescue packages, which may lead to even higher increases, notably in public debt.
Significant risks to the growth forecasts, firmly tilted to the downside
This forecast is surrounded by considerable uncertainty and downside risks are significant. Most importantly, the financial stress may intensify even further, last longer or have a more pronounced impact on the real economy, fuelling the negative feedback loop. This could also reinforce the ongoing correction of some housing markets, putting balance sheets under increasing strains, which could both hamper the necessary deleveraging process in the financial sector and, via negative wealth and confidence effects, reduce private consumption. Moreover, abrupt shifts in risk-preferences cannot be ruled out in such a situation, and countries with sizeable external deficits and/or debts in particular could face increasing difficulties in securing their financing. Future commodity prices, on the other hand, are more likely to fall (than increase) as growth prospects deteriorate. This would ease inflationary pressures and makes risks for consumer price inflation more balanced.
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