EU growth seen at 2.9% in 2007

The European Union economy is expected to grow by 2.9% in 2007 and 2.7% in 2008 (2.6% and 2.5%, respectively, in the euro area) on the back of solid investment and stronger private consumption, according to the Commission’s spring economic forecasts. Such growth levels imply an upward revision of ½ percentage point in 2007 for both areas compared to the autumn. The EU as a whole is predicted to create almost 9 million new jobs over the period 2006-2008, 6 million of which for the euro area alone. This will help to reduce EU unemployment to less than 7% in 2008 from 8¾% in 2005. The economic recovery will continue to improve public finances, with the general government deficit forecast to fall to around 1% in both the EU and the euro area – a level not seen in many years. Inflation is expected to remain contained, although the outlook is for a slight pick-up of underlying inflation over the forecast horizon, mirroring the renewed increase in oil prices and the cyclical recovery.

“The European Union and the euro area remain on a brisk growth path that should reduce the unemployment rate and the average public deficit further to levels not seen in a long time. We must help sustain the economic recovery by putting public finances firmly on a sounder footing and by pursuing the reform process. This, in turn, will cut public debts and help increase the growth potential before the ageing problem starts kicking in” said Joaquín Almunia, the Economic and Monetary Affairs Commissioner.

Three years growing above potential

The Commission’s economic forecast project economic growth to stay well above potential over the forecast horizon although decelerating marginally from 3% in 2006 to 2.9% in 2007 in the EU (from 2.7% to 2.6% in the euro area). The new forecast for 2007 is ½ pp higher than six months ago for both areas.

The stronger outlook is partly explained by a better-than-expected  2006, which marked the strongest pace of expansion in six years. Domestic demand has proven more dynamic, with investment supported by high corporate profitability, still-benign financing conditions, a high rate of capacity utilisation and optimistic business sentiment. Private consumption is being spurred by a substantial improvement in the labour market situation. EU growth also continues to be supported by a solid outlook for the world economy, especially the emerging economies, which largely compensates for the US slowdown.

Looking further ahead, economic activity in 2008 is projected to moderate marginally to 2.7% in the EU and 2.5% in the euro area, thus still remaining above potential. This deceleration reflects somewhat lower external demand and the lagged impact of the gradual withdrawal of monetary stimulus on domestic demand.

Positive outlook for job creation and public finances

EU employment growth almost doubled in 2006 to 1.5% (1.4% in the euro area), which is the strongest rise since 2000 and corresponds to almost 3½ million new jobs  (2 million of which in the euro area). This improvement was broad-based across sectors and countries.

The economy is expected to generate robust employment growth of around 1¼% on average in 2007-2008 in both the EU and the euro area. Taken together, nearly 9 million jobs will have been created in the EU over the period 2006-2008, including almost 6 million in the euro area. This should lead to a reduction of the unemployment rate   to 6.7% in the EU and 6.9% in the euro area by 2008, levels not known since the early 1990’s.

Wages are expected to increase but to stay moderate during the forecast period, especially as labour productivity growth is seen firming. This bodes well for consumer price inflation expected to stay close to 2%. Nevertheless, excluding the impact of the VAT hike in Germany in 2007, underlying inflation edges up in 2008 in line with a strengthening domestic demand.

Public finances also turned out markedly better than expected in the autumn as the average budget deficit fell from 2.3% of GDP in 2005 to 1.7% last year in the EU (from 2.4% to 1.6% in the euro area), mainly on the back of higher tax revenues. This should have a positive impact throughout the forecast period with the deficit falling to 1.2% of GDP this year in the EU (1% in the euro area). A further decline is foreseen for 2008 to 1.0% in the EU and 0.8% in the euro area based on the usual no-policy-change assumption. This would be the lowest deficit level since 2000.

Despite this overall improvement, five Member States, including one euro-area member, would still run a deficit of more than 3% of GDP this year.

Risks on external front

On the external side there are positive and negative risks. On the one hand, the global economy could grow stronger, in particular in Asia. On the other hand, a more marked slowdown in the US housing market would have a negative impact on global growth as would have a disorderly unwinding of global current account imbalances. Finally, further geopolitical tensions could also lead to new oil-price hikes.

However, the outcome could also turn out better on account of a labour market performance even more favourable than forecast, which would give an extra boost to private consumption.

The full Commission spring economic forecast is available on the internet at:

http://ec.europa.eu/economy_finance/publications/european_economy/forecasts_en.htm