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European economy heading for troubled waters

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European economy heading for troubled waters

Pierre Moscovici - Photo EC

(BRUSSELS) - The Eurozone is heading for a period of high uncertainty, according to the EU's latest economic forecast, released Thursday, as it faces trade conflicts, rising geopolitical tensions, manufacturing weakness and Brexit.

The European Commission's Autumn 2019 Economic Forecast reports the European economy in its seventh consecutive year of growth and forecast to continue expanding in 2020 and 2021, with labour markets strong and unemployment falling.

However, the external environment has become "much less supportive and uncertainty is running high", says the report. This is particularly affecting the manufacturing sector, which is also experiencing structural shifts. As a result, the European economy looks to be heading towards a protracted period of more subdued growth and muted inflation.

Growth has been downgraded from the Commission's summer forecast. Euro area gross domestic product (GDP) is now forecast to expand by 1.1% in 2019 and by 1.2% in 2020 and 2021. Compared to the Summer 2019 Economic Forecast (published in July), the growth forecast has been downgraded by 0.1 percentage point in 2019 (from 1.2%) and 0.2 percentage points in 2020 (from 1.4%). For the EU as a whole, GDP is forecast to rise by 1.4% in 2019, 2020 and 2021. The forecast for 2020 was also revised down compared to the summer (from 1.6%).

Economic Affairs Commissioner Pierre Moscovici insisted that the fundamentals of the EU economy are robust: "after six years of growth, unemployment in the EU is at its lowest since the turn of the century and the aggregate deficit below 1% of GDP."

But he added that "the challenging road ahead leaves no room for complacency. All policy levers will need to be used to strengthen Europe's resilience and support growth."

On trade tensions, the report says persisting trade tensions between the US and China and high levels of policy uncertainty, especially with respect to trade, have dampened investment, manufacturing and international trade. With global GDP growth set to remain weak, growth in Europe will depend on the strength of more domestically-oriented sectors. These, in turn, will rely on the labour market supporting wage growth, favourable financing conditions, and, in some Member States, supportive fiscal measures. While all Member States should continue to see their economies expand, domestic growth drivers alone are unlikely to be sufficient to power strong growth.

Improvements in the labour market are set to slow. Job creation across the EU, surprisingly resilient with a shift in employment towards service sector, and employment is at a record high and unemployment in the EU is at the lowest level since the start of the century.

Although net job creation is likely to slow, the unemployment rate in the euro area is expected to continue falling from 7.6% this year to 7.4% in 2020 and 7.3% in 2021. In the EU, the unemployment rate is forecast to fall to 6.3% this year and settle at 6.2% in 2020 and 2021.

Inflation in the euro area has slowed so far this year due to the fall in energy prices and because firms have largely chosen to absorb the cost of higher wages in their margins rather than pass them on to customers. Inflationary pressures are expected to remain muted over the next two years. Euro area inflation (Harmonised Index of Consumer Prices) is forecast at 1.2% this year and next, rising to 1.3% in 2021. In the EU, inflation is forecast at 1.5% this year and next and 1.7% in 2021.

Europe's public finances are set to continue benefitting from the very low interest rates due on outstanding debt. Despite lower GDP growth, the euro area's aggregate public debt-to-GDP ratio is forecast to continue declining for the fifth year in a row to 86.4% this year, 85.1% in 2020 and 84.1% in 2021. The same factors hold true for the EU, where the public debt-to-GDP ratio is forecast to fall to 80.6% this year to 79.4% in 2020 and 78.4% in 2021.

Government balances, by contrast, are expected to deteriorate slightly due to the impact of lower growth and somewhat looser discretionary fiscal policies in some Member States. The euro area's aggregate deficit is forecast to rise from an historic low of 0.5% of GDP in 2018 to 0.8% this year, 0.9% in 2020 and 1.0% in 2021, under a no-policy change assumption. However, the euro area aggregate fiscal stance, i.e. the aggregate change in the 19 euro area Member States' structural budget balance, is expected to remain broadly neutral. In the EU the aggregate deficit is also expected to rise, from 0.7% of GDP in 2018 to 0.9% this year, 1.1% in 2020, and 1.2% in 2021.

A number of risks could lead to lower growth than forecast. A further increase in uncertainty or a rise in trade and geopolitical tensions could dampen growth, as would a sharper-than-expected slowdown in China due to weaker effects from policy measures enacted so far. Closer to home, risks include a disorderly Brexit and the possibility that weakness in the manufacturing sector could have a bigger spillover effect on domestically-oriented sectors.

On the upside, an easing of trade tensions, stronger growth in China and lower geopolitical tensions, would support growth. In the euro area, growth would also benefit if Member States with fiscal space were to choose more expansionary fiscal policy stances than expected. Overall, however, the balance of risks remains decidedly to the downside.

In the light of the process of the withdrawal of the UK from the EU, the Commission notes that projections are based on a purely technical assumption of status quo in terms of trading patterns between the EU27 and the UK. This is for forecasting purposes only and has no bearing on the process underway in the context of Article 50, it says.

Autumn 2019 Economic Forecast - full document


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