Spring economic forecast 2022: Russian invasion tests EU's economic resilience

The prospects for the EU economy before the outbreak of war augured well for a prolonged and robust expansion. However, Russia's invasion of Ukraine has created new difficulties, just when the Union had recovered from the economic fallout of the pandemic. By putting new upward pressure on commodity prices and causing further supply shocks and increased uncertainty, the war is exacerbating pre-existing obstacles to growth that had previously been expected to diminish. This has led the European Commission to revise EU growth prospects downwards and inflation forecasts upwards.

Growth slowing as the war exacerbates pre-existing bottlenecks

EU GDP is expected to remain positive over the forecast period, thanks to the combined effect of the post-containment reopenings and the strong policy measures taken to support growth during the pandemic. In particular, private consumption will be supported by the post-pandemic reopening of services involving many people-to-people contacts, a strong and further improving labour market, lower savings accumulation and fiscal measures to offset higher energy prices. Investment will benefit from the full implementation of the Recovery and Resilience Mechanism and the accompanying reform agenda.

Real GDP growth in both the EU and the euro area is projected at 2.7% in 2022 and 2.3% in 2023, compared to 4.0% and 2.8% (2.7% in the euro area), respectively, in the 2022 winter interim forecast. The projected decline in 2022 should be read in the context of the growth momentum accumulated by the economy in the spring and summer of last year, which adds around two percentage points to this year's annual growth rate. Output growth over the year has slowed from 2.1 % to 0.8 %.

The main shock to the world and EU economies is in energy commodity prices. Although they had already risen sharply before the war from low levels during the pandemic, uncertainty over supply chains has put upward pressure on prices and increased their volatility. This applies to food and other basic goods and services, leading to a decline in household purchasing power.

War-induced logistics and supply chain disruptions, as well as rising input costs for a wide range of raw materials, add to global trade disruptions caused by the continuing drastic COVID-19 containment measures in parts of China, which negatively affect production.

Energy prices push inflation to record highs

Inflation has gained momentum since the beginning of 2021. From 4.6% year-on-year in the last quarter of 2021, it rose to 6.1% in the first quarter of 2022. Headline inflation in the euro area rose to 7.5% in April, the highest rate in the history of the monetary union.

Inflation in the euro area is projected to stand at 6.1% in 2022 and to moderate to 2.7% in 2023. For 2022 as a whole, this represents a considerable upward revision compared with the 2022 interim winter forecast (3.5%). Inflation is expected to peak at 6.9% in the second quarter of this year and to gradually decline thereafter. For the EU as a whole, inflation is projected to rise from 2.9 % in 2021 to 6.8 % in 2022 and to fall to 3.2 % in 2023. Average core inflation is forecast to exceed 3% in 2022 and 2023 in both the EU and the euro area.

Strong and improving labour market

The labour market is entering the new crisis on a good footing. More than 5.2 million jobs were created in the EU economy in 2021, bringing almost 3.5 million more people into the labour market. In addition, the number of unemployed decreased by almost 1.8 million people. Unemployment rates at the end of 2021 fell below previous historical lows.

Labour market conditions are expected to improve further and employment in the EU is projected to increase by 1.2% this year, although this annual rate of increase is boosted by the strong momentum recorded in the second half of last year. People fleeing the war in Ukraine to the EU are expected to enter labour markets only gradually, with tangible effects only visible from next year onwards.

Unemployment rates are forecast to fall further, to 6.7% this year and 6.5% in 2023 in the EU and to 7.3% and 7.0% in 2022 and 2023 respectively in the euro area.

Government deficits continue to fall, but war-related costs rise

Despite the costs of measures to alleviate the impact of high energy prices and to support people fleeing Ukraine, the aggregate government deficit in the EU is projected to continue to decline in 2022 and 2023, as temporary support measures for COVID-19 continue to be withdrawn. From 4.7% of GDP in 2021, the EU deficit is projected to decline to 3.6% of GDP in 2022 and 2.5% in 2023 (3.7% and 2.5% in the euro area).

After declining to around 90% in 2021 (97% in the euro area) from the historical peak of almost 92% of GDP in 2020 (almost 100% in the euro area), the EU aggregate debt-to-GDP ratio is projected to decline to around 87% in 2022 and 85% in 2023 (95% and 93% in the euro area, respectively), remaining above the pre-COVID-19 level.

Uncertainty and risks hinge on war developments

Risks to the outlook for economic activity and inflation depend to a large extent on developments in the war and, in particular, its impact on energy markets.

Given the high uncertainty, the baseline forecast is accompanied by a scenario analysis based on models simulating the impact of higher energy commodity prices as well as a total disruption of gas supplies from Russia. Under the latter, more severe scenario, GDP growth rates would be around 2.5 and 1 percentage point below the baseline forecast in 2022 and 2023, respectively, while inflation would increase by 3 percentage points in 2022 and by more than 1 percentage point in 2023 above the baseline forecast.

In addition to these potential energy supply disruptions, worse-than-expected supply chain problems and further increases in non-energy commodity prices, especially for food, could lead to further downward pressures on growth and upward pressures on prices. Higher than expected second-round effects in the face of an import-related inflationary shock could exacerbate stagflationary forces. Stronger inflationary trends are also accompanied by higher risks in terms of financing conditions. Finally, COVID-19 remains a risk factor.

Apart from these immediate risks, Russia's invasion of Ukraine is leading to economic dissociation of the EU from Russia, with consequences that are difficult to fully assess at this stage.

Context

This forecast is based on a number of technical assumptions about exchange rates, interest rates and commodity prices up to the cut-off date of 29 April. For the other data considered, including assumptions on government policies, these forecasts take into account information up to and including 29 April. The assumptions are based on the assumption of no policy change unless new policies are announced credibly and in sufficient detail.

The European Commission publishes two full forecasts (spring and autumn) and two interim forecasts (winter and summer) each year. The interim forecasts include annual and quarterly GDP and inflation for the current and the following year for all Member States, as well as aggregate data at EU and euro area level.

The European Commission's Summer Economic Forecasts 2022 will be presented in July 2022, updating the GDP and inflation forecasts.