Outlooks for EU growth and inflation worsen as energy crisis hits

Brussels is set to cut its growth forecasts further and lift its inflation outlook as the energy crisis triggered by Russia’s invasion of Ukraine exacts its toll on the EU economy.

Both the EU and euro area are forecast to expand by 2.7 per cent this year, well shy of the previous expectation of 4 per cent, according to a draft of European Commission forecasts to be published on Monday. Growth is tipped to be 2.3 per cent in 2023.

Inflation is expected to surge above 6 per cent in both the EU and euro area this year, with some central and eastern European countries likely to see double-digit price rises in 2022.

Eurozone inflation is set to fall to 2.7 per cent in 2023. But the figure remains above the European Central Bank’s target of 2 per cent, underscoring the delicate balancing act policymakers face in an environment of tepid growth and soaring prices.

Last week, central bank president Christine Lagarde signalled that she would support raising the main interest rate in July, paving the way for the first increase for more than a decade. The commission previously forecast that inflation would fall back below the ECB’s target next year.

Energy costs have soared and confidence has faltered in the wake of the invasion of Ukraine.

EU member states have pushed through five rounds of sanctions, and are now in the process of seeking to finalise a package targeting the oil sector. Those measures have yet to be agreed, however, given resistance from EU member states heavily reliant on Russian oil — most notably Hungary.

Commission officials remain engaged in talks with Budapest, as well as the Czech Republic and Slovakia, over special terms to help them wean themselves off Russian energy.

While Europe’s economy is still set to expand this year, the commission has stressed that some of the growth is down to a statistical boost coming from momentum that built up last year. The threats to growth, meanwhile, are building.

The commission’s draft analysis suggests that if there were an outright cut in gas supply from Russia, coupled with higher energy commodity prices, the economy would suffer even more damage.

Growth this year would be lowered by 2.5 percentage points to just 0.2 per cent under this scenario, while a percentage point would be shaved off the 2023 growth forecast. Inflation would be 3 percentage points higher than the baseline projection in 2022 and one percentage point higher in 2023.

Some economists want the European Commission to announce another suspension to its deficit and debt rules next year.

Alongside energy prices, which were up 38 per cent year on year in April in the euro area, households are being hit by higher food costs, which were up more than 6 per cent in the same period.

Industrial production is still being impeded by supply-chain disruptions. China’s harsh Covid-19 lockdown is further damaging global trade, while the US outlook is increasingly uncertain given the Federal Reserve’s need to clamp down on inflation without imposing too brutal a clampdown on activity.

Despite the harsh outlook, the commission still expects unemployment to carry on falling following the surge induced by Covid-19. The jobless rate will drop from 7.7 per cent last year to 7.3 per cent in 2022 in the euro area, according to the draft forecasts, before slipping further to 7 per cent in 2023.

Budget balances are also expected to gradually improve. The overall euro area budget gap is predicted to drop from 5.1 per cent of GDP last year to 3.7 per cent this year and 2.5 per cent in 2023.