The European Central Bank has unveiled a significant set of staff macroeconomic projections for the euro area. This release has far-reaching implications for both policymakers and investors. The projections, released on Thursday 14 September 2023 underscore the difficulties confronting the euro zone, including declining business and consumer confidence, stagnant employment, with the number of jobseekers across the euro zone expected to rise marginally to 6.7% by 2025.
This release coincided with the ECB’s announcement of its tenth consecutive interest rate hike--a substantial 450 basis points over the past fourteen months. This move likely signifies the policy-setting governing council’s commitment to tackling inflation, even while grappling with economic challenges, particularly in the manufacturing sector. This highlights the delicate balancing act between inflation control and the stimulation of economic growth.
The ECB report outlines a gloomy short-term growth outlook for the euro area. Despite early-year indications of robust manufacturing orders, economic activity across the region has remained lacklustre. Key contributing factors to this stagnation include tightening financial conditions and reduced foreign demand.
Average annual real GDP growth is forecasted to plummet from 3.4% in 2022 to just 0.7% in 2023, recovering modestly to 1.0% in 2024 and 1.5% in 2025.
When compared with Eurosystem staff projections from June 2023, the outlook has been downwardly revised by 0.2 percentage points for 2023, 0.5 points for 2024, and 0.1 points for 2025. This downward revision reflects worsening survey indicators, unfavourable credit supply and a robust euro exchange rate.
Industrial output weakened in the second quarter despite a backlog of orders and eased supply bottlenecks. Service sector activity was the lone bright spot, showing positive quarterly growth in gross value added. In terms of consumption, both private consumption and business investment have been softer than anticipated, affected by high inflation and tight credit conditions. As a result, overall growth for the latter half of 2023 is expected to remain broadly flat, down by 0.6 percentage points relative to the June 2023 projections.
The ECB anticipates a gradual moderation in headline inflation over the coming years. After peaking at an average of 8.4% in 2022, inflation is forecasted to decrease to 5.6% in 2023, 3.2% in 2024, and 2.1% in 2025, finally aligning with the ECB’s medium- to long-term 2% target. The primary drivers behind this slowing inflation include reduced cost pressures, positive monetary policy effects and diminishing shocks from energy prices.
The core harmonised index of consumer prices (HICP) inflation, which excludes volatile energy and food, is also projected to decline but will remain above headline inflation until early 2024. This disinflationary trend stems largely from the fading impacts of past energy price shocks and other transitory factors, with growing labour costs set to become the dominant inflationary force in the coming years. Notably, the September projections have been adjusted to reflect a more than 10% upward revision in oil prices due to supply constraints and concerns over Chinese demand.
Investment and employment
The report highlights concerns over both business and housing investments. Business investment is expected to suffer in the near term due to weak economic conditions, elevated interest rates, and credit constraints. Conversely, housing investment is faltering due to increasing mortgage rates and declining property values.
As for the employment outlook, it remains subdued. The ECB forecasts a meagre 1.2% growth in employment for 2023, with a virtually stagnant rate of 0.2% for both 2024 and 2025. The sluggish employment market can be attributed to the deteriorating economic conditions and a predicted uptick in unemployment from its historical low of 6.4% to 6.7% by 2025.
Revised projections and future implications
The revisions in economic forecasts for 2023, 2024 and 2025 are noteworthy, especially the 0.5 percentage-point downward adjustment for 2024. This is mainly due to tighter financial conditions and weakened foreign demand.
Both private consumption and business investment are anticipated to be significantly impacted, raising concerns about the euro area’s prospects for recovering to pre-pandemic economic activity levels in the near term.
In a landscape characterised by rising interest rates, a robust euro and anaemic economic growth, the ECB may need to pivot its policy direction sooner rather than later.