War in Russia worsens outlook: Commission’s summer interim forecast

The EU economy has been hit by several shocks…

Economic developments in the past two months have forced a deep reassessment of the EU’s growth and inflation outlook.

First, European gas spot and futures prices have risen significantly over the past few weeks. This follows declining gas supplies from Russia and concerns about future supplies (IEA 2022). Electricity price futures also increased, especially for the winter season of both 2022 and 2023 (see Figure 1).

Figure 1 Estimate energy product prices

Disagree: Estimates are based on a 10-day moving average of futures prices. For estimation of wholesale electricity prices, weighted average of data from DE, FR, IT, ES, NL, BE and AT is used.
formula: ICE Future Europe.

Second, as evidence of rising price pressures, the ECB and other EU central banks are poised to accelerate the end of monetary support. Markets now expect short-term interest rates to rise even faster (see Figure 2). Long-term government bond yields also rose. Tightening credit standards, rising corporate yields and a major correction in equity valuations contributed to a less favorable financial position.

Figure 2 The yield curve between the euro area and the US

Disagree: average equivalent yield rate, the average yield over the reference period of the forecast estimate (June 17–30 for SF22 and April 14–27 for SF22).
formula: ECB for the Euro Area, US Treasury Department.

Third, global growth is weakening. Logistics and supply-chain disruptions continue to hamper global activity, although there are signs of easing. The fallout from the strict Covid-related lockdown implemented in China appears to be greater than previously expected, while the looming crisis in China’s property sector, a mainstay of growth in recent years, could have a lasting negative impact on the country’s growth prospects. . US growth is also set to weaken as the Fed acts aggressively to control record inflation and a soft landing becomes increasingly questionable (Domash and Summers 2022). Real global GDP growth (excluding the EU) is now expected to rise to 3.0% in 2022 and 3.3% in 2023, 0.3 percentage points and 0.4 percentage points lower, respectively, than in the European Commission’s spring forecast (European Commission 2022a).

Finally, economic sentiment took a strong hit in the European Union following Russia’s aggression in Ukraine, especially among consumers, whose confidence fell to levels close to the historic dip of April 2020, at the start of the Covid-19 pandemic. The rise in the euro area household savings rate recorded in the first quarter likely reflects not only the reintroduction of pandemic-related measures, which limited consumption opportunities at the start of the quarter, but also a significant decline in confidence.

…setting it on a low growth path…

These developments force a profound reassessment of the EU’s economic outlook. The European Commission’s summer interim forecast (European Commission 2022b) expects real GDP to grow by 2.7% in the EU and 2.6% in the euro area this year (see Table 1).1 After a stronger-than-expected first quarter earlier this year, economic activity is expected to weaken in the second quarter, but a promising tourism season should regain some traction in the summer. In 2023, economic growth is expected to gain some momentum due to a resilient labor market, lower inflation, support from the Recovery and Resilience Facility (RRF) and still substantial excess savings. Still, at 1.5% in the EU and 1.4% in the euro area, growth rates expected for the year as a whole are lower than the 2.3% expected in the spring for both regions.

Table No. 1 Summary: Summer 2022 interim forecast

and high inflation

The rapid rise in prices in recent months suggests that annual inflation will remain elevated in 2022 Further external and domestic price pressures in the second half of the year are set to add to inflation carried over from its higher reading till June. Inflation in the EU is now expected to peak at 8.9% in the 3rd quarter of 2022 (8.4% in the euro area), a quarter later than forecast in the spring. HICP strength inflation is expected to drive a steady decline in headline inflation through 2023. Food inflation will remain high in 2022 and moderate in 2023, reflecting the upward pressure currently operating across the food value chain. . The lagged effect of the euro’s devaluation, higher input costs, supply-side constraints (including labor shortages), and rising wages are all set to keep core inflation down through 2023 – as more volatile energy and food shortages contribute. Overall, annual average inflation is projected at 7.6% in 2022 and 4.0% in 2023 in the euro area (and 8.3% and 4.6% respectively in the EU). Revisions to our previous inflation estimates are substantial as inflation is expected to persist into the first half of next year before falling sharply. By the end of the forecast horizon, headline inflation, at 2.5%, is still above the ECB target.

Low-income families are paying a higher toll…

The increase in price levels between January 2021 and June 2022 has already increased per capita household spending in the EU by around €160 per month on average (see box in European Commission 2022b). Low-income households are hit hardest by high energy bills and food prices, as a large portion of their spending is on these basics. On average in the European Union, expenditure on food, electricity and gas is about 22% of total expenditure for households in the poorest quintile, compared to 15% for the highest income quintile. Data from the EC Consumer Survey (European Commission 2022c) reveal that for all income quartiles from July 2021 consumers’ assessment of the past and expected financial situation of their households has worsened, but the proportion of respondents who have received, or will receive, a much worse assessment is significantly higher among lower income groups. (Figure 3). Similarly, the share of respondents who are in financial distress – that is, falling into savings or debt – is increasing across the board (Figure 4), but reaches new heights among low-income households (European Commission 2022d).

Figure 3 Share of consumers in the EU reporting that their household’s financial situation has worsened significantly in the past 12 months

Figure 4 Share of respondents in the EU reporting their household is in a financial crisis

Member States have introduced several measures to reduce the impact of high energy prices on consumers (Sgaravatti et al. 2022). Most of these measures (about two thirds in terms of total revenue expenditure at EU level) can be classified as pricing policy, directly targeting the value of final energy provided by households and firms These include reductions in indirect taxes (including excise duties on energy) or tariffs, subsidies, direct price intervention and social levies. These measures come at a high revenue cost and, by reducing the price paid by consumers, they reduce the incentive to reduce (fossil) energy consumption.

…ensuring targeted support that can be sustained over the medium run…

As the reality of long-term high energy prices sinks in, Member States should reassess the trade-offs between such price policy and income policy in the form of compensation paid to energy consumers through cash or in-kind transfers.

The benefits of such an income policy are manifold (Bethewen et al. 2022). By targeting vulnerable households, they support purchasing power where needed and without suppressing price signals. This would preserve market incentives for households and businesses to convert to more energy-efficient technologies. Finally, lower energy intensity leads to lower imports and improves the terms of trade. More targeted income policies would bring fiscal policies closer to the optimal (broadly neutral) fiscal position, thus facilitating debt reduction in member states with high debt. The Eurogroup Statement on Fiscal Policy Orientation for 2023 (European Council 2022) encourages such policy coordination.

Finally, a cacophony of different short-term price adjustments across member states complicates the ECB’s task by increasing the divergence of price pressures within the euro area and distorting the inflationary pass-through path of power after price policy takes effect and eventually vice versa.

… without interfering with efforts to accelerate the transfer of power

At the EU level, these policies are complemented by policy efforts aimed at front-loading the energy transition. REPowerEU, in particular, sets out a number of measures aimed at energy savings, energy supply diversification, and increasing renewable energy. The Commission proposes to place the RRF at the heart of the implementation of the REPowerEU plan, providing additional EU funding. Under the Commission’s REPowerEU proposal, Member States will be able to add a REPowerEU chapter to their recovery and resilience plans to channel investments and necessary reforms to REPowerEU priorities. Funding to this end will come from remaining RRF loans (currently €225 billion), voluntary transfers from the Common Agricultural Policy and Integrated Policy Fund (up to €53 billion) and new RRF grants financed by auctioning EU Emissions Trading System allowances. , is currently held in market stability reserves worth 20 billion euros.

Ultimately, the only way to reduce the macroeconomic vulnerability arising from the current high energy dependence is to accelerate the decarbonisation of the EU economy.

reference

Bethuyne, G, A Cima, B Döhring, Å Johannesson Lindén, R Kasdorp, J Varga (2022), “Targeted income support is the most social and climate-friendly measure to mitigate the impact of high energy prices”, VoxEU.org, 6 June .

European Commission (2022a), “Russian attack tests EU economic resilience”, European Economics Institutional Paper 173, May.

European Commission (2022b), “Russia’s War Worsens Outlook”, European Economics Institutional Paper 183, July.

European Commission (2022c), “Results of the Business and Consumer Survey for June 2022”, DG ECFIN, June.

European Commission (2022d), “European Business Cycle Indicators”, Technical Paper 57, DG ECFIN, June.

European Council (2022), “Eurogroup Statement on the Monetary Policy Orientation for 2023”, Eurogroup Statements and Commentaries, 11 July.

Domash, A and L Summers (2022), “Extremely warm conditions indicate high likelihood of US recession”, VoxEU.org, 13 April.

International Energy Agency (2022), Gas Market Report, Q3-2022July 2022.

Sgaravatti, G, S Tagliapietra and G Zachmann (2022), “National policy to protect consumers from rising energy prices”, Bruegel Dataset, 6 July.

Endnote

1 Estimated annual growth rates for this year are driven by momentum gathered with last year’s recovery and a slightly stronger first quarter than previously estimated in the spring forecast.

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