News Release
No.
26/03
April 8, 2003
EU COMMISSION RELEASES SPRING ECONOMIC FORECASTS
FOR 2003/2004
The
euro area and European
Union economy ended 2002 on a very weak note due to global uncertainties and persistent
structural rigidities that reduce our capacity to react to shocks. Continued sluggishness
is expected to prevail in the first half of this year. Assuming that
geo-political tensions abate before the summer, the return of confidence and
lower oil prices would trigger a moderate recovery in the second half of 2003.
It is unlikely to be a vigorous rebound as the rise in unemployment weighs on
consumption, the protracted fall in stock markets affects corporate balance sheets
and oil prices continue to put pressure on inflation. Consequently, for a third
consecutive year growth is likely to disappoint: the average growth rate is expected
to be a meager 1% in 2003 in the euro area (1.3% in the EU). A more solid average
growth rate of 2.3-2.4% is projected in the euro area and EU next year when employment
creation resumes, investment picks up and the international environment is more
supportive. However, given the high level of uncertainty, a further delay in the
acceleration of growth cannot be excluded.
Geo-political tensions, volatile oil prices and the protracted fall in stock markets
cloud the short-term outlook
At
the present juncture, uncertainty is particularly high and the outlook depends
more than ever on the views one takes on exogenous factors. Underlying the European
Commission projections is the assumption that the geo-political tensions related
to the war in Iraq will have ended by mid-year leading to an improvement in confidence
and a normalization of international relations.
The
oil price assumptions suggest a gradual decline from $31 (Brent crude) in the
first quarter of this year towards $25.5 per barrel in the last quarter of this
year resulting in an average oil price of $27.5 in 2003. A further easing to $23.5
is assumed for next year.
With
equity prices falling about 60% from the peak levels in spring 2000, the speed
and size of the stock market correction are comparable to the 1929 crash. While
the reduction in household wealth and the pressure on balance sheets of financial
institutions and firms will put a lid on economic expansion, continued low growth
is projected in the baseline scenario.
Moderate and unbalanced global recovery
The
international tensions are reflected in another year of weak world trade growth
at 2.6% in 2002 after a contraction of 0.5 % in 2001, a trough not seen since
1982-83. Although accelerating to 5.4%, also this year foreign trade is unlikely
to be a motor of the global recovery. World GDP growth has been revised down to
3.2% in 2003—hardly an acceleration from last year—but in 2004 world GDP should
increase by a more robust 3.7%. The recovery is unbalanced as reflected in the
widening current account and government deficits.
In
the US, helped by a monetary and fiscal policy stimulus and solid underlying productivity
growth, the modest recovery is expected to continue with growth at about 2.5%
in 2003 and 2004. GDP growth remains below potential as household balance sheet
adjustments, together with remaining under-utilization of capacity and the drag
from the external balance contain the strength of the recovery. The budget deficit
widens to 4.8% of GDP in 2003 and the current account deficit to 6.1% in 2004.
The
economic outlook for Japan remains bleak and the government deficit could widen
to 7% of GDP, but in the rest of Asia growth continues to be buoyant, despite
weak export markets outside the region. After a stagnation in 2002, Latin America
is expected to recover moderately, benefiting from the currency depreciation,
a pick-up in the world economy and the gradual resolution of the financial crises
which hit several countries in the region. Growth is expected to remain robust
in Canada and Australia. Also in the countries preparing for accession on May
1, 2004, continued strong growth is forecast supported by domestic demand and
structural change, notwithstanding the weakness in the EU.
The euro area and EU recovery lost momentum in the second half of 2002
The
euro area economy grew by a meager 0.9% in 2002 (1.1% for the EU) and momentum
faded in the second half of that year. Euro area GDP expanded by 0.2% in the last
quarter of 2002 compared to 0.4% in the previous quarter.
While the driving forces of the recovery shifted promisingly to domestic demand,
private consumption failed to strengthen and remained at 0.7% in 2002 in the euro
area (1.4% in the EU). Higher than expected inflation eroded purchasing power,
poor job creation dampened real disposable income growth and the continued decline
in equity prices reduced household wealth. This is, however, not enough to explain
sluggish consumer spending. An important factor is uncertainty, which reduces
confidence and pushes up the savings rate. There are the geo-political tensions
linked to Iraq and the uncertainties related to future labor and pension income.
Recently, in particular, the latter has become a source of concern because of
the diminished equity value of pension funds and the deterioration of public finances
in some member states.
Investment barely turned the corner after one-and-a-half-years of continuous decline.
There was just a stabilization in the last quarter of 2002 partially linked to
a better control of unit labor costs, and for the year as a whole investment contracted
by 2.3% in the euro area (-2.4% in the EU).
Prospects remain bleak in the very short run but a recession is likely to be avoided
Consumer confidence continued to decline in the beginning of this year and is
now at levels observed in September 1992 when the EU entered a recession. However,
consumers may overreact to the military conflict in the Middle East. In addition,
business confidence is still above recession levels, while industrial production
and retail trade, though remaining weak, recovered somewhat from the dramatic
fall at the end of last year. Taken together, these indicators suggest continued
slow growth in the first half of this year but a recession in the EU as a whole
is unlikely. Only in Germany GDP is forecast to shrink in the second quarter.
It
is assumed that geo-political tensions will abate in the second half of this year,
setting the stage for a rebound in economic activity. Nevertheless, the average
growth in the euro area remains limited to 1% in 2003 and 2.3 % in 2004 (1.3%
and 2.4% in the EU, respectively).
After last year's decline, investment is forecast to expand by a mere 0.3% in
2003 in the euro area as demand prospects are weak and balance sheet concerns
in the corporate sector remain. On the other hand, some replacement of production
capacity is necessary because of depreciation. Furthermore, financial conditions
have improved (lower bank lending rates and corporate bond spreads) and also profitability
but this is partly achieved through an intensified labor market adjustment. Consumer
spending is expected to increase by 1.2% on average in the euro area this year
as there may be some pent-up demand after several quarters of subdued consumption
which could be freed if confidence returns. On the other hand, the rise in unemployment
is likely to be a constraining factor on household consumption. World trade is
expected to pick up but euro area exporters are likely to lose some market share
due to the appreciation of the euro. However, the strengthening of the euro reduces
inflation in the euro area, thus raising real disposable income.
The labor market adjustment is starting to bite
In
the initial phase of the slow growth period employment held up quite well and
the rise in the unemployment rate remained limited. This was the result of the
large share of employment in the more stable service sector, the possibility of
reducing working hours rather than jobs thanks to less rigid contracts and some
labor hoarding as the downturn was expected to be mild. However, now the resilience
of the labor market appears to be weakening. In 2003 some 100,000 jobs (in net
terms) are expected to be lost in the euro area (the first decline since 1994)
and the unemployment rate is forecast to increase to 8.8% (8% in the EU). Given
the sluggish recovery, only modest job creation is foreseen next year which remains
outpaced by the increase of the labor force so that unemployment continues to
rise. The number of unemployed people would increase by 1.4 million in the euro
area in 2002-2004.
Resilient headline inflation
Despite the economic slowdown, inflation is in general slow to decline in 2003
and is expected to remain at 2.1% on average in the euro area compared to 2.2%
last year, only falling below 2% next year. High oil prices and a rise in indirect
taxes have kept inflation from decreasing more, and it takes time for the strengthened
euro and improved outlook for unit labor costs to exert their downward pressure
on prices. In some countries, inflation continues to remain very low due to the
sharpness of the slowdown, leading to wide inflation differentials in the euro
area.
Further deterioration of the general government deficit but considerable differences
at the member state level
The
general government deficit at the euro area level widened significantly to 2.2%
of GDP in 2002 (1.9% in the EU). Compared to the Commission Autumn Forecast, the
French deficit has been revised up to 3.1% of GDP, while the Portuguese deficit
has been revised down below the 3% threshold; the German deficit was revised down
to 3.6% of GDP. Better outcomes than expected were noted in Ireland (equilibrium),
Austria (smaller deficit) and Finland (larger surplus). The United Kingdom and
the Netherlands had worse results.
At
the euro area level, the deterioration of the general government balance remains
contained to 2.5% of GDP in 2003 (2.3% in the EU) despite ongoing economic weakness,
because some countries plan to limit the effect of the automatic stabilizers on
the actual deficit. This is the case of Germany, Ireland and the Netherlands,
all three of which reduce their cyclically adjusted deficit by at least 0.5% of
GDP; in Italy the effort is smaller. Germany remains, however, in excessive deficit.
Conversely, the cyclically adjusted deficit in the UK moves sharply further away
from equilibrium. In France
and Portugal, the cyclically adjusted deficits remain high and the actual deficits
are above the 3% ceiling, although in the case of Portugal
the authorities are considering measures to avoid such an outcome. Also in Greece,
the cyclically adjusted deficit is wide.
The
budgetary forecasts for 2004 are made as usual on the basis of unchanged policies,
and three countries (France, Italy, Portugal) would have a deficit above 3%, while
three other (Germany, Netherlands, United Kingdom) are in the danger zone.
A
worse outcome is possible
There is considerable uncertainty around the Commission projection and a worse
outcome cannot be excluded as the war against Iraq may last longer than earlier
anticipated. Furthermore, conditions are fragile, both globally and in the EU,
making economies more sensitive to shocks. In this respect, three issues are of
particular concern: (i) weak confidence; (ii) growing budgetary and current account
imbalances; (iii) the protracted fall in stock markets impacting negatively on
household and corporate balance sheets.
A
worst case scenario would include a protracted military conflict, high oil prices,
a fall in international travel, a decline in foreign direct investment and world
trade and a deterioration of confidence affecting consumption and investment.
In such a case, the euro area and EU may face stagnation this year and the return
to potential growth would be delayed to later in 2004.
More detailed information on the forecasts is available in European Economy, published
on the Internet at:
http://europa.eu.int/comm/economy_finance/publications/
european_economy/forecasts_en.htm
and at:
http://europa.eu.int/comm/economy_finance/publications/
enlargement_papers/elp15_en.htm
for
EU candidate countries' economic forecasts.
Press Contacts: |
Willy Hélin
202-862-9530
|
Wilfried Schneider
202-862-9523
|
|
Maeve O'Beirne
202-862-9549
|
|
