…with downward risks increasing
Based on an update for the seven largest Member States in the European Union, the Commission forecasts economic growth in 2007 at 2.8% in the EU and 2.5% in the euro area. This represents a downward revision of 0.1 percentage points (pp) compared with the spring forecast.
European growth is expected to remain supported by sound fundamentals and a still favourable global environment. Nevertheless, the recent turbulence has clearly increased the downward risks to this outlook.
On the inflation front, consumer prices in 2007 are expected to increase by 2.2% in the EU and 2.0% in the euro area (up by 0.1 pp. compared with the spring) as higher commodity prices take their toll.
“The sound economic fundamentals of the European economy will help weather the current financial turmoil. But the increased risks to the outlook require governments to hold steady to the reform and budgetary consolidation agenda, precisely to enhance the resilience of the EU economy,” said JoaquÃn Almunia, Economic and Monetary Affairs Commissioner.
This year’s economic growth is expected at 2.8% in the EU and 2.5% in the euro area, a downward revision of 0.1 pp compared with the spring forecast that reflects mainly a weaker-than-expected second quarter, according to the interim forecast of the Commission’s Economic and Finance Affairs Directorate General.
The forecast is derived from an update of the outlook of real GDP growth and inflation for
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Global environment remains favourable despite turmoil
The European economies started 2007 on a strong note with GDP expanding by 0.7% quarter-on-quarter (q-o-q) in both the euro area and the EU driven, above all, by buoyant investment. Real GDP growth eased in Q2 to 0.3% q-o-q in the euro area (0.5% in the EU). The weaker second-quarter growth rate should be interpreted with some caution. The quarterly figures were affected by the impact of the unusually mild winter weather in Q1 on construction investment, reversed by harsher weather causing a marked slowdown in Q2. But it could also mean that growth peaked in the course of last year, a development which could be reinforced by the impact of the recent turmoil in the financial markets.
The turbulence that originated from problems in the US sub-prime mortgage market during the summer has caused a disorderly re-pricing of risks in global assets markets. Uncertainty about underlying losses has resulted in an aversion for risk and increased corporate bond spreads as well as in a withdrawal of liquidity and higher volatility in several markets.
Since both the global and the European economies were generally sound ahead of the recent turbulence, they ought to be able to weather the current turmoil, at least if it proves to be short-lived. At present, the global economy is even expected to grow somewhat faster in 2007 than forecast in spring, as stronger growth in emerging economies, especially China, more than offsets a downward revision of US growth. However, the recent distress has clearly tilted the balance of risks to the downside. This is particularly the case for the US, where housing demand fell sharply.
Against this background, the update for the seven largest EU economies indicates the positive outlook from the spring forecast is largely maintained. This follows from several factors: the global economic environment remains relatively favourable; a higher-than-expected growth in Q1; fundamentals continue to be sound; survey indicators weakened somewhat lately, but are still at high levels; and the improved labour-market situation should underpin private consumption.
Domestic demand is expected to continue to be the main contributor to GDP growth in both the euro area and the EU, with output increasingly driven by private consumption. This would reflect the persistent signs of improvement in the European labour markets, not least in Germany. The unemployment rate, which fell below 7% in both the EU and the euro area during the summer, is now at levels not seen since the early 1980s.
Looking further ahead, the updated outlook for 2007Â points to a somewhat reduced growth momentum in 2008 than forecast last Spring, with the additional risk that the impact of the distress in the financial markets becomes significant in the coming year.
Inflation slightly higher on rising commodity prices
Inflation remained contained so far in 2007 due to favourable base effects in energy prices. Consumer price inflation amounted to 1.9% in the first half of 2007 in the euro area, broadly in line with the spring forecast and declining from the previous year. In contrast, core inflation increased by 0.3 pp. between December 2006 and July 2007. This up-tick seems mostly related to the VAT increase in Germany.
Looking ahead, the projections for consumer price inflation have been revised upwards by about 0.1 pp for 2007 in both areas: to 2.2% in the EU[1][1] and 2.0% in the euro area. This upward revision is mainly due to higher-than-expected inflation in Q2 and the projected impact of rising commodity prices towards the end of the year. For instance, based on the futures market, the average price for Brent crude is estimated at $68 per barrel in 2007, $1¾ more than assumed in the spring forecast.
However, a pick-up in labour productivity and intense international price competition should contribute to keep inflation in check. As tighter financing conditions start to dampen GDP growth further out, domestic inflationary pressures are likely to ease.
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Risk assessment
Developments since the spring have increased the downside risks to the forecasts for both the second half of 2007 and 2008, in particular concerning the outlook for the
