European Commission’s Spring Economic Forecast 2023: Resilient Growth in EU Economy

The European economy continues to show resilience in a difficult global context, according to the European Commission (EC), publishing its spring economic forecast. Lower energy prices, easing supply constraints and a strong labor market contributed to moderate growth in the first quarter of 2023, allaying fears of a recession. Therefore, the start of the year is better than expected and it raises the EU economic growth outlook to 1.0% in 2023 (0.8% in winter interim forecast) and 1.7% in 2024 (1.6% in winter).

The upward revisions are similar for the euro area, with GDP growth now forecast at 1.1% and 1.6% in 2023 and 2024, respectively. Due to persistent underlying price pressures, the inflation forecast was also revised higher compared to the winter, to 5.8% in 2023 and 2.8% in 2024 in the euro area.

According to Eurostat’s preliminary flash estimate, in the first quarter of 2023, GDP grew by 0.3% in the EU and by 0.1% in the eurozone. Key indicators point to further growth in the second quarter.

The European economy has managed to limit the negative impact of Russia’s war of aggression against Ukraine – it has overcome the energy crisis thanks to the rapid diversification of supply and a significant reduction in gas consumption. Significantly lower energy prices affect the entire economy by reducing production costs for businesses. Consumers are also feeling the pinch in energy bills, although private consumption is expected to remain modest as wage growth lags behind inflation.

With inflation still high, financing conditions are expected to tighten further. While the ECB and other EU central banks are thought to be nearing the end of their rate hike cycle, recent turmoil in the financial sector is likely to increase the cost of credit and make it more difficult to access, slowing investment growth and particularly affecting housing investment, the EC said.

After peaking in 2022, headline inflation continued to decline in the first quarter of 2023 as energy price increases slowed sharply. However, core inflation (total inflation excluding energy and unprocessed food) has proved more resilient. Core inflation reached a historic high of 7.6% in March, but is expected to ease gradually over the forecast period as profit margins absorb pressure from higher wages and financing conditions tighten. The April estimate of the harmonized index of consumer prices for the euro area, published after the cut-off date for this forecast, shows a small fall in the level of core inflation, suggesting that it may have peaked in the first quarter, as forecast. According to the annual data, core inflation in the Eurozone will average 6.1% in 2023, but will decrease to 3.2% in 2024, remaining above the general inflation level in both forecast years.

An unprecedentedly strong labor market strengthens the resilience of the EU economy. The unemployment rate in the EU reached a new record low of 6% in March 2023, and participation and employment rates are at unprecedented highs.

The EU labor market is expected to react only slightly to a slower economic growth rate. Employment growth is forecast to be 0.5% this year, but to decrease to 0.4% in 2024. The unemployment rate is expected to remain slightly above 6%. Wage growth has accelerated since the start of 2022, but has so far been well below inflation. It is expected that in connection with the persistently tight situation in the labor market, the significant increase in the minimum wage in several countries and, more generally, the pressure of workers to recover the lost purchasing power, a longer increase in wages is expected.

It is expected that the state budget deficit will decrease, especially in 2024

Despite measures to cushion the impact of high energy prices, strong nominal growth and the lifting of remaining pandemic-related measures meant that the EU’s general government deficit continued to decline in 2022 to 3.4% of GDP. In 2023, and more markedly in 2024, the decline in energy prices should allow governments to phase out energy support measures, contributing to further deficit reductions to 3.1% and 2.4% of GDP, respectively. The EU’s total debt-to-GDP ratio is projected to gradually fall below 83% (90% in the euro area) in 2024, which is still above pre-pandemic levels. The fiscal trajectories of Member States are very heterogeneous.

Although inflation can improve public finances in the short term, this effect fades over time as debt service costs rise and government spending gradually adjusts to higher price levels.

More persistent core inflation could continue to constrain household purchasing power and lead to a tighter monetary policy response, with wide-ranging implications at the macro-financial level. In addition, renewed episodes of financial stress could increase risk aversion, leading to tighter lending standards than anticipated in this forecast. An expansionary fiscal policy approach would further fuel inflation by interfering with monetary policy measures. In addition, the global economy may face new challenges following a turmoil in the banking sector or related to broader geopolitical tensions. On the positive side, more favorable trends in energy prices would lead to a sharper decline in headline inflation, with a positive impact on domestic demand. Finally, the uncertainty of Russia’s invasion of Ukraine remains.

Executive Vice-President of the EC Valdis Dombrovskis, commenting on the EC’s spring economic forecast for Latvia, states that according to the EC’s spring economic forecast, the EU economy will grow by 1% this year. The main cause of slow economic growth remains the consequences of Russia’s aggression against Ukraine, however, compared to previous forecasts, economic indicators have slightly improved. Latvia’s economy will grow by 1.4% this year – slightly ahead of the EU average and showing the highest growth rate among the Baltic countries. It is predicted that a gradual decrease in inflation will boost private consumption in the second half of this year, while a more active uptake of EU funding will boost investment.

For comparison, the Lithuanian economy will grow by 0.5% this year, while a 0.4% recession is expected in Estonia. Inflation both in the EU as a whole and in the Baltic countries is gradually decreasing, but this year it will still be at a relatively high level. Inflation in all three Baltic countries is forecast to be 9.2%-9.3% this year, well above the EU average of 6.7%, Dombrovskis emphasizes.

The EC publishes two comprehensive forecasts (spring and autumn) and two interim forecasts (winter and summer) every year. Interim forecasts include annual and quarterly GDP and inflation for the current year and next year for all Member States, as well as for the European Union and the euro area as a whole.