Economy in EU and Europe still resilient but recessions here and there are almost unavoidable

Economy in EU and Europe still resilient but recessions here and there are almost unavoidable

The economic situation in the EU and in the Euro area is marked by the large gap between the current situation, which is still fairly resilient, and the firm expectation that a hefty downturn is on the horizon. For this year, growth in the Euro area and in the EU is still forecast to reach a good result of around three percent in real terms before dropping to almost zero next year.

In the first two quarters of the current year, economic activity in the Euro area was still growing at a robust pace (up 0.6 percent and 0.8 percent year on year) and even managed to remain above zero in the third quarter (up 0.2 percent year on year) despite the energy price and inflation shock. Among the major economies, Italy expanded the most, growing 0.5 percent, followed by Germany (up 0.3 percent), France and Spain (both up 0.2 percent). The catch-up demand following the pandemic brought the southern European countries a good tourist season in the summer with the Recovery and Resilience Fund of the Next Generation EU package also propping up investment.

Growth to be very low in 2023

All analysts agree that the prospects of the Euro area for the fourth quarter and the next year are much less rosy. Back in July, the European Commission was forecasting real growth rates of more than one percent and even in September, the ECB regarded growth of almost one percent to be within reach (0.9 percent), but the OECD, the IMF and European peak association (BusinessEurope 2022) have downwardly revised growth prospects to between 0.25 and 0.5 percent growth. We expect real private consumption expenditure and state consumption in the Euro area to stagnate and marginal growth in fixed gross capital formation.

Investment activity will suffer and remain feeble

The cost and inflation shock, subdued demand prospects in North America and the continued uncertainty surrounding the Ukraine war will, we believe, sharply decrease corporate investment activity. The OECD still forecasts slight growth in fixed gross capital formation of just under one percent. The full impact of the monetary measures will also have reached corporate financing towards the end of 2023. Furthermore, many companies are still having a hard time passing on the increased purchase prices (above all for energy) to their product prices. While purchase prices have risen considerably (by a good 40 percent), many industries are not able to transfer much of the cost pressure onto product and final consumer prices due to contractual provisions or international competition. This price passthrough will take some time yet as there is a limit to how much of these costs can be absorbed by squeezing profit margins and insolvency risks have risen drastically in many energy-intensive industries. All these factors are keeping investment activity down. The construction sector is already feeling the brunt of the more stringent financing conditions and is facing a plunge from its very robust current level, which will also greatly restrain construction investment. Public investment, on the other hand, is set to continue for many countries with the EU Recovery and Resilience plans, which will help prop up investment levels.

Private households must absorb cost shock and are reducing spending

Real consumption expenditure is being curbed by the cost shock and the loss of purchasing power in real terms. Consumer confidence in the Euro area has tumbled since summer 2021. We do not expect

this to be compensated by reduced savings rates as these have already declined steeply and households are increasingly limiting their spending instead. Real consumption expenditure will thus trend sideways.

Heterogeneous trends among member states

Prospects are bleak for most of the major economies in the Euro area: Germany is set to undergo a marked slump in economic activity. France and Italy are likely to stagnate or record moderate growth at best (OECD 2022, BusinessEurope 2022, Confindustria 2022). The peripheral countries of Europe are in slightly better shape. Spain’s economy is slightly less affected by the energy crisis and should still manage growth of 1.5 percent. Most Central and Eastern European countries are likely to remain on a low growth path, with the exception of Hungary, which is heading for a deep recession.

France facing weak year in 2023

France has not been quite as badly impacted by the price shock as Germany and Italy on account of its economic structure and energy mix. It also introduced price-based support measures promptly and recently bolstered these with more targeted measures for households and enterprises. These steps have kept inflation to below average rates and have secured solid growth for this year of around 2.5 percent. The reduction in the purchasing power of private households and the cost burden for enterprises will nonetheless keep real consumption expenditure and investment very low next year. Foreign trade will not deliver any real momentum either.

Stagnation in Italy

Italy has been hit very hard by the energy shock due to its economic and energy structure, which is very similar to Germany’s. Mario Draghi’s government rapidly initiated support measures to the volume of three percent of GDP and managed to swiftly organise alternative energy supplies. The large-scale Recovery and Resilience Plan for Italy has strongly kick-started public investment in the country (by a good one percentage point of economic output) although some elements of the plan are running behind schedule. Inflationary pressure in Italy is nonetheless high and the typical effects on consumption and private investment expenditure, particularly those of energy-intensive companies, are already broadly evident. The energy costs for companies have more than doubled this year (Confindustria 2022). Industrial production and retail sales have been in steep decline since the summer. At least summer tourism boomed. Due to the high level of public debt and the greatly increased spread to Germany, loans for Italian companies and households have become a lot more expensive, despite the scope of the ECB to contain speculative attacks with the Transmission Protection Instrument. This increase in the cost of credit is not based on a deterioration of Italy’s fiscal indicators. On the contrary, the support measures are being financed primarily by the additional revenue from increased inflation, and public debt is set to fall by almost five percentage points of economic output due to inflation and will not rise in 2023. Whether and to what extent the Meloni government will switch to a more expansionary fiscal course remains to be seen. The budget submitted to Brussels sets out moderate increases in expenditure, so policy scope is limited. Inflation will keep demand low next year, while foreign trade is likely to have very little effect on growth. The export of goods and services has increased by more than ten percent this year. A repeat performance is out of the question for next year, with growth in exports forecast at just under two percent for 2023.