Europe slashes its growth forecast

Economic growth across the EU will slow in 2008 because of a weaker US economy and problems in global financial markets, the European Commission says. Brussels is now forecasting 2.4% growth in the 27-member union in both 2008 and 2009, compared to 2.7% this year.

In the 13-member eurozone, growth is expected to slow to 2.2% next year, down from the 2.6% projected for 2007.

European banks have not been immune to the global credit crisis triggered by the slump in the US housing market.

However, a still benign global environment and solid fundamentals limit the downward revision to 0.3 percentage points (pp.) in 2008 for both areas compared to the spring forecast. In particular, private consumption, which became the main driver of growth earlier this year, is expected to grow at a healthy pace, underpinned by relatively sustained employment growth.

The EU as a whole is predicted to create 8 million new jobs over the period 2007-2009, on top of the 3.5 million already created in 2006. This will help reduce EU unemployment to 6.6% in 2009.

Thanks in part to this healthy economic activity, the budget deficit for 2007 in both the EU and the euro area is forecast to fall to its lowest level in many years, averaging 1.1% of GDP in the EU and 0.8% in the euro area.

The structural deficit is also expected to improve this year, albeit to a lesser degree, though fiscal consolidation will come to a halt thereafter. Inflation is set to increase in the coming quarters as a result of higher commodity prices, but should fall back to around 2% by mid-2008 in the euro area.

The Commission’s economic forecast projects economic growth to moderate over the forecast horizon, decelerating from 2.9% in the EU in 2007 to 2.4% in both 2008 and 2009 (and, in the euro area, from 2.6% in 2007 to 2.2% in 2008 and 2.1% in 2009). The Commission’s central forecast assumes that the financial distress will peter out gradually. On the external side, EU growth continues to be supported by a solid outlook for the world economy, especially the emerging economies, which largely compensates for the slowdown in the US. Therefore, the Commission sees the EU economy growing at around potential in the two forecast years. Inflation, however, is expected to accelerate to 2.4% in the euro area in the coming quarters on the back of higher commodity prices, but to fall back to around 2% next summer.

The main downside risks to the growth outlook relate to the events in financial markets and the possibility of a sharper or more protracted slowdown in the US. Some segments of the financial markets are still malfunctioning, and a more prolonged period of uncertainty cannot be ruled out, affecting credit conditions and, in turn, housing markets more acutely than anticipated. On the other hand, the labour market could again surprise on the upside, which would boost labour income and consumer confidence. As regards inflation, further oil-price hikes and rises in food and commodity prices present upside risks to the baseline scenario.