Brussels: Europe and the Arabs
Almost a year after Russia launched its war of aggression against Ukraine, the European Union economy entered 2023 on a better footing than expected in the fall. The interim winter forecast raises growth forecasts for this year to 0.8% in the EU and 0.9% in the Eurozone. Both areas are now set to avoid the technical slump that was expected for the start of the year. The forecast also slightly lowers inflation expectations for both 2023 and 2024, according to what the European Commission recently published in Brussels.

Outlook improves thanks to enhanced flexibility

After a strong expansion in the first half of 2022, growth momentum eased in the third quarter, although slightly less than expected. Despite the exceptional headwinds, the EU economy avoided a contraction expected in the fourth quarter in the autumn outlook. The annual growth rate for 2022 is now estimated at 3.5% in both the EU and the Eurozone.

Positive developments since the fall outlook have improved the growth outlook for this year. The continued diversification of supply sources and a sharp decline in consumption left gas storage levels above the seasonal average of past years, and wholesale gas prices fell below pre-war levels. In addition, the EU labor market continued to perform strongly, with the unemployment rate remaining at an all-time low of 6.1% through the end of 2022. Confidence is improving and January surveys suggest that economic activity is also poised to avoid a contraction in the first quarter of 2020. 2023.

However, headwinds are still strong. Consumers and businesses still grapple with rising energy costs and core inflation (core inflation excluding energy and unprocessed food) still rose in January, further eroding households' purchasing power. As inflationary pressures persist, monetary policy tightening is set to continue, affecting business activity and exerting a drag on investment.

The projected growth of the 2023 interim winter forecast of 0.8% in the EU and 0.9% in the euro area is 0.5 and 0.6 bps higher, respectively, than in the autumn forecast. The growth rate for 2024 remained unchanged at 1.6% and 1.5% in the European Union and Eurozone, respectively. By the end of the forecast horizon, production volumes are set to be approximately 1 percent higher than expected in the fall forecast.

Having peaked in 2022, inflation will decline over the projection horizon

Three consecutive months of moderate headline inflation suggest that the peak is now behind us, as projected in the fall outlook. After reaching an all-time high of 10.6% in October, inflation has fallen, with the January flash estimate dropping to 8.5% in the Eurozone. This decline was mainly driven by declining energy inflation, while core inflation has not yet peaked.

Inflation expectations were revised downward slightly from the fall, mainly reflecting developments in the energy market. The headline inflation rate is expected to decline from 9.2% in 2022 to 6.4% in 2023 and to 2.8% in 2024 in the European Union. In the euro area, it is expected to slow from 8.4% in 2022 to 5.6% in 2023 and to 2.5% in 2024.

Risks to the outlook are more balanced

While uncertainty surrounding the forecast remains high, risks to growth are broadly balanced. Domestic demand could turn higher than expected if recent declines in wholesale gas prices are passed through to consumer prices more strongly and consumption is more resilient. However, a possible reversal of that fall cannot be ruled out in the context of ongoing geopolitical tensions. External demand may also turn out to be more robust after China reopens - which could, however, lead to an increase in global inflation.

Inflation risks remain largely related to developments in energy markets, reflecting some specific risks to growth. Particularly in 2024, upside risks to inflation prevail, as price pressures may turn out to be broader and more entrenched than expected if wage growth is to hold at above-average rates for a sustained period.