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Russia's war with Ukraine hits EU growth outlook

18 May 2022, 22:43 CET
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Russia's war with Ukraine hits EU growth outlook

Paolo Gentiloni - Photo - © European Union 2022

(BRUSSELS) - The European Union downgraded its forecasts for economic growth Monday, as Russia's invasion of Ukraine leads to a surge in energy prices and drives inflation to record highs.

The European Commission's Spring 2022 Economic Forecast showed the outbreak of Russia's war with Ukraine putting an end to the earlier prolonged and robust expansion forecast.

"Russia's invasion of Ukraine is causing untold suffering and destruction, but is also weighing on Europe's economic recovery," said the EU's Economy Commissioner Paolo Gentiloni: "The war has led to a surge in energy prices and further disrupted supply chains, so that inflation is now set to remain higher for longer."

EU GDP is still projected to remain in positive territory over the forecast horizon, thanks to the combined effect of post-lockdown re-openings and the strong policy action taken to support growth during the pandemic.

The post-pandemic re-opening of contact-intensive services, a strong and still improving labour market, lower accumulation of savings and fiscal measures to offset rising energy prices are set to support private consumption.

Real GDP growth in both the EU and the euro area is now expected at 2.7% in 2022 and 2.3% in 2023, down from 4.0% and 2.8% (2.7% in the euro area), respectively, in the Winter 2022 interim Forecast. The EU executive says the downgrade for 2022 must be read against the background of the growth momentum gathered by the economy in spring and summer last year, which adds around 2 percentage points to the annual growth rate for this year. Output growth within the year has been reduced from 2.1% to 0.8%.

The main hit to the global and EU economies comes through energy commodity prices. Although they had already increased substantially before the war, from the low levels recorded during the pandemic, uncertainty about supply chains has pressured prices upwards, while increasing their volatility. This is true for food and other basic goods and services, with households' purchasing power declining.

War-induced logistics and supply chain disruptions, as well as rising input costs for a broad array of raw materials, add to the disturbances in global trade caused by the drastic COVID-19 containment measures still applied in parts of China, weighing on production.

Inflation has been picking up momentum since early 2021. From 4.6% year-on-year in the last quarter of 2021 it went up to 6.1% in the first quarter of 2022. Headline inflation in the euro area surged to 7.5% in April, the highest rate in the history of the monetary union.

Inflation in the euro area is projected at 6.1% in 2022, before falling to 2.7% in 2023. For 2022 as a whole, this represents a considerable upward revision compared to the Winter 2022 interim Forecast (3.5%). Inflation is expected to peak at 6.9% in the second quarter of this year and decline gradually thereafter. For the EU, inflation is expected to increase from 2.9% in 2021 to 6.8% in 2022, and fall back to 3.2% in 2023. Average core inflation is projected above 3% in 2022 and 2023 in both the EU and the euro area.

Labour market conditions are expected to continue to improve. Employment in the EU is projected to grow by 1.2% this year, though this annual growth rate is spurred by the strong momentum in the second half of last year. People fleeing the war in Ukraine to the EU are expected to enter labour markets only gradually, with tangible effects only becoming visible from next year.

Unemployment rates are forecast to decline further, to 6.7% this year and 6.5% in 2023 in the EU and to 7.3% and 7.0% in 2022 and 2023 respectively in the euro area.

On government deficits, despite the costs of measures to mitigate the impact of high energy prices and to support people fleeing Ukraine, the aggregate government deficit in the EU is set to decline further in 2022 and 2023 as temporary COVID-19 support measures continue to be withdrawn. From 4.7% of GDP in 2021, the deficit in the EU is forecast to fall to 3.6% of GDP in 2022 and 2.5% in 2023 (3.7% and 2.5% in the euro area).

After decreasing in 2021 to around 90% (97% in the euro area) from the historic peak of almost 92% of GDP in 2020 (almost 100% in the euro area), the aggregate debt-to-GDP ratio of the EU is forecast to decline to around 87% in 2022 and 85% in 2023 (95% and 93% in the euro area, respectively), remaining above the pre-COVID-19 level.

Regarding risks, the Commission says these are heavily dependent on the evolution of the war, and especially on its impact on energy markets.

Given the high uncertainty, the baseline forecast is accompanied by a model-based scenario analysis that simulates the impact of higher energy commodity prices, as well as of an outright cut in gas supply from Russia. In this latter, more severe scenario, GDP growth rates would be around 2.5 and 1 percentage points below the forecast baseline in 2022 and 2023, respectively, while inflation would increase by 3 percentage points in 2022 and by more than 1 in 2023, above the baseline projection.

On top of such potential disruptions in energy supply, worse than expected problems in supply chains and further increases in non-energy commodity prices, especially food, could lead to additional downward pressures on growth, and upward pressures on prices. Greater than expected second round effects in the face of an imported inflationary shock could compound stagflationary forces. Strong inflationary pressures also come with increased risks to financing conditions. Finally, COVID-19 remains a risk factor.

Beyond these immediate risks, Russia's invasion of Ukraine is leading to an economic decoupling of the EU from Russia, with consequences that are difficult to fully apprehend at this stage.

Spring 2022 Economic Forecast: full document

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