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Brussels curbs growth forecasts as inflation hits EU economy

The surge in energy prices is set to exert a “more protracted drag” than expected on the European economy this year and drive higher inflation, the European Commission said in its latest growth outlook.

Growth this year would fall short of previous forecasts, the commission said. It predicted a 4 per cent expansion in the EU and eurozone for 2022, compared with its 4.3 per cent forecast last autumn. Output growth would ease to 2.8 per cent in the EU in 2023 and 2.7 per cent in the eurozone, it said.

In forecasts published on Thursday, the commission said inflation was expected to surge to 3.9 per cent this year in the EU and 3.5 per cent in the eurozone — much higher than previously expected, before subsiding to less than 2 per cent in 2023.

The predictions highlight the extent to which supply chain bottlenecks and rising energy prices, combined with the outbreak of the Omicron variant of coronavirus, are imposing a near-term drag on the EU’s economic rebound.

The commission remains broadly optimistic about the outlook once the disruptions die down, predicting the EU will remain in a “prolonged and robust expansionary phase” thanks to a strong labour market and rising household spending.

“Multiple headwinds have chilled Europe’s economy this winter: the swift spread of Omicron, a further rise in inflation driven by soaring energy prices and persistent supply chain disruptions,” said Paolo Gentiloni, the EU’s economy commissioner. “With these headwinds expected to fade progressively, we project growth to pick up speed again already this spring.”

The region’s economy regained its pre-pandemic level last summer, and output is predicted to surpass levels prior to the Covid-19 crisis in all 27 member states by the end of this year. However, the surge in inflation, which hit record levels in the eurozone in the fourth quarter, is set to cast a cloud over the economic outlook for the coming months.

The inflation rate is set to peak in the first quarter of 2022 and stay above 3 per cent until the third quarter, according to commission projections. The biggest driver has been energy price growth, which was nearly 26 per cent in the eurozone in December. Gas and electricity continue to trade at record levels and prices are expected to moderate significantly only in 2023, the commission warned.

The build-up of Russian military forces on the Ukraine border and in Belarus has heightened concerns about the impact of high energy prices on the EU economy, given Russia provides around 40 per cent of its gas imports.

The commission warned that risks to growth and inflation were being “aggravated” by the geopolitical tensions in eastern Europe.

Nevertheless, it predicted inflation would fade next year, taking the headline rate of consumer price growth to 1.9 per cent in the EU and 1.7 per cent in the eurozone in 2023, since the current pressures were largely driven by “the post-pandemic adjustment and energy and non-energy commodity volatility”.

The EU’s inflation forecast, which was revealed by Bloomberg several hours before publication, gave ammunition to those arguing that the European Central Bank should not rush to tighten monetary policy in response to higher than expected inflation.

The ECB sparked a sell-off in bond markets last week when it said inflation risks were “tilted to the upside”, fuelling expectations that it would next month raise its own forecast for annual price growth in 2023 and 2024 above its 2 per cent target — fulfilling a key condition to raise interest rates. In December, the ECB forecast inflation would drop to 1.8 per cent next year.

“The EU commission forecasts euro area inflation to decline to 1.7 per cent in 2023,” Frederik Ducrozet, a strategist at Pictet Wealth Management and veteran ECB-watcher, wrote on Twitter. “If so, the ECB should ease, not tighten.”

Eurozone government bond prices rallied after the EU forecast was published.

However, the commission said it stopped considering new data for its latest forecasts a day before publication of the flash estimate for eurozone inflation, which rose to a record 5.1 per cent, defying widespread expectations of a fall. The January figure “presents some upside risks to our first quarter forecast”, it added.

The tightening of the eurozone labour market during the economic recovery had “not put noticeable pressure on wages so far”, it said. Negotiated wages in the eurozone, for example, increased by 1.3 per cent in the third quarter of 2021 from a year earlier, the slowest pace since the pandemic began.

Interruptions to supply chains have also hit growth and inflation. The commission expected bottlenecks in the transport and metals sectors to ease gradually during the current year, while semiconductor shortages would take until 2023 to resolve.

Valdis Dombrovskis, European Commission executive vice-president, said: “The significant rise in inflation and energy prices, along with supply chain and labour market bottlenecks, are holding back growth. Looking ahead, however, we expect to switch back into high gear later this year as some of these bottlenecks ease.”

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