EU.Review

By Keith Zahra

Prolonged War, High inflation raises concern on growth prospects

The European Union had approached the beginning of 2022 with positivity driven by an expansionary phase on the back of an improving health situation, a growing labour market, significant accumulated savings and the disbursement of millions of euro as part of the Recovery and Resilience Facility. The prolonged war in Ukraine has diluted such expectations, resulting in significant pressure on commodities, including energy and grain, and increased uncertainty.

Energy prices had already rebounded strongly from the peak days of the pandemic as supply struggled 26

to match the global economic rebound. However, given the Russian dominance of the oil and gas market, prices edged up further, and with EU leaders reaching an agreement earlier this month to significantly reduce purchases from the belligerent nation, the full impact might yet to be seen.

The war has impacted other commodities, including some industrial metals such as nickel and copper, as well as neon gas, which is a key input for semiconductors.

High inflation levels are expected to impact significantly consumer purchasing power, particularly for lower income families who tend to

devote a higher percentage of their available income on such items. Indeed, there are already indications that towards the end of the first quarter, consumption growth in the EU has paused, though economists are still positive that government support measures, a strong labour market and the post-pandemic increase in expenditure will continue to support economic expansion.

Growth remains strong in Q1: In the first quarter of 2022, seasonally adjusted GDP increased by 0.2% in the euro area and by 0.4% in the EU, compared with the previous quarter, according to a preliminary flash estimate published by Eurostat, the statistical office of the European Union. In the fourth quarter of 2021, GDP had grown by 0.3% in the euro area and 0.5% in the EU. Compared with the same quarter of the previous year, seasonally adjusted GDP increased by 5.0% in the euro area and by 5.2% in the EU in the first quarter of 2022, after +4.7% in the euro area and +4.9% in the EU in the previous quarter. The year-onyear growth rates were positive for all countries.

Inflation takes the headlines: Despite this positive growth, it was inflation, however, that continued to take the headlines, reaching yet another record in May, reaching a staggering 8.1% from 7.4% in April. Prices have risen sharply across Europe over the past year, initially on supply chain problems after the pandemic, then following Russia’s invasion of Ukraine, impacting energy and fuel prices significantly. This is expected to create challenges to the European Central Bank which had for months held the view that gradual interest rate increases from July will be enough to tame stubbornly high price growth.

Retail on the move: In the euro area in March 2022, compared with March 2021, the volume of retail trade increased by 8.3% for automotive fuels, and by 2.8% for non-food products, while it fell by 2.5% for food, drinks and tobacco, according to Eurostat data. Among Member States, the highest yearly increases in the total retail trade volume were registered in Slovenia (+25.6%), Estonia (+18.4%) and Malta (+16.4%). The largest decreases were observed in Denmark (-11.0%), Spain (-4.8%), and Belgium (-3.9%).

Industry struggles: In March 2022, the seasonally adjusted industrial production fell by 1.8% in the euro area and by 1.2% in the EU, compared with February 2022, according to estimates from Eurostat, the statistical office of the European Union. In February 2022, industrial production increased by 0.5% in the euro area and by 0.6% in the EU. In March 2022 compared with March 2021, industrial production decreased by 0.8% in the euro area and increased by 0.7% in the EU.

A job-seekers market: Another factor which experts consider might be contributing to inflation is the persistent skills gap which is challenging firms across the continent, as unemployment levels decline further. In 2021, the EU economy added some 5.2 million jobs and attracted nearly 3.5 million more people into the labour market. With unemployment rates at record-low levels, a rapid increase in unfilled vacancies and a growing share of firms reporting labour shortages as a factor limiting their production, labour markets in the EU have tightened.

In April 2022, the euro area seasonally-adjusted unemployment rate was 6.8%, stable compared

with March 2022 and down from 8.2% in April 2021. The EU unemployment rate was 6.2% in April 2022, also stable compared with March 2022 and down from 7.5% in April 2021. Compared with April 2021, unemployment decreased by 2.543 million in the EU and by 2.175 million in the euro area.

Uncertainty going forward: Forecasting the future has been made harder given the evolving situation in Ukraine. The lengthening of the crisis could further increase import prices with a significant negative impact on domestic demand and by consequence on public budgets. Uncertain economic activity in the United States and China also add to the challenges ahead. COVID-19 also remains a risk factor, as the lockdowns in Shanghai and other parts of China earlier this year have proven. The growth forecast for the world economy in 2022 has been downgraded by more than 1% compared to the previous forecast. Economists expect Real GDP growth in the EU to remain subdued in the second quarter of 2022. High energy prices, persistent supply-side disruptions and the unfolding effects from Russia’s invasion of Ukraine are expected to dampen growth dynamics in the second quarter. The performance of the services sector, buoyed by the removal of pandemic restrictions, is expected to remain the bright side of the economy.

The EU Spring Economic Forecast argues that private consumption could prove more resilient to increasing prices if households were to use more of their savings for consumption. Investments fostered by the RRF could generate a stronger impulse to economic activity. Finally, an accelerated reduction of fossil fuel dependency and green transition could reduce the negative impact of high energy prices faster than assumed.

Despite such hopes, the EU has revised downwards its expectations for 2022. GDP growth is expected to slow down from 5.4% in 2021 to 2.7% in 2022 in both the EU and the euro area, the latter being 1.3% than originally forecast last Winter. Annual GDP growth should moderate further in 2023, to 2.3% in the EU and the euro area, which is markedly lower than expected in the winter (2.8% in the EU, 2.7% in the euro area). The Commission expects that the positive effects of the Recovery and Resilience Plans are set to be a key driver of public investment, even if the realisation of several planned investments may be affected by supply bottlenecks (e.g. material scarcity) and cost increases. Public investment in the EU is projected to increase stronger than GDP, raising the public investment-to-GDP ratio for a fifth consecutive year, from 3.2% last year to 3.4% in 2022 and 3.5% in 2023.

Improving fiscal positions: As Governments across the continent have gradually withdrawn temporary measures taken in response to the pandemic, deficit rates in the EU have fallen down from 4.7% of GDP in 2021 to an expected 3.6% this year, despite the additional costs – forecasted at 0.6% of GDP to cushion the impact of high energy prices. Despite this improvement, a number of political leaders and economists have already questioned whether the suspension of fiscal rules should remain in place for a year longer. The debt-to-GDP ratio for the EU as a whole is set to decline to 85% of GDP by 2023, remaining above the pre-COVID-19 crisis level.

Sources: Eurostat EU Spring Economic Forecast