EU recovery stalls amid financial market crisis

GDP growth is now expected to remain subdued in the second half of the year, coming close to standstill at year-end, the latest figures show.

The EC believes the soft patch predicted in the spring forecast is now likely to deepen but will not result in a double dip. On account of the stronger-than-expected performance in the first quarter, annual growth is still projected at 1.6% in the euro area and 1.7% in the EU.

However, growth forecasts for the second half of the year have been revised down considerably, by 0.5% for the euro area as well as the EU compared to the Commission's spring forecast. Moreover, the current outlook is uncertain, and the balance of risks to this forecast is to the downside.

EU Economic and Monetary Affairs Commissioner Olli Rehn said: "The outlook for the European economy has deteriorated. Recoveries from financial crises are often slow and bumpy. Moreover, the EU economy is affected by a more difficult external environment, while domestic demand remains subdued.

“The sovereign debt crisis has worsened, and the financial market turmoil is set to dampen the real economy. To get the recovery back on track, it is crucial to safeguard financial stability and put budgets on a path that is sustainable beyond doubt.

“This requires steadfast continuation of the strategy of differentiated, growth-friendly fiscal consolidation and the implementation of the decisions to support financial stability. At the same time, structural reforms remain more important than ever to build tomorrow's growth potential."

Growth forecasts revised down

The EC’s interim forecast contains updated projections for GDP growth and inflation for the seven largest EU Member States, the euro area and the EU for 2011. The next forecast covering all EU Member States and looking further ahead will be released in November.

GDP growth for 2011 as a whole is set to remain unchanged from the Commission's spring 2011 forecast for the euro area (1.6%) and to be slightly lower for the EU (1.7%). This is largely owed to stronger-than-expected growth in the first quarter.

However, the quarterly growth profile for the second half of the year has been revised down considerably. Growth projections for the EU are now at 0.2% in both the third and the fourth quarter, 0.2% in the third and 0.1% in the fourth quarter for the euro area, respectively.

For both areas the quarterly growth rates were revised down by about 0.25%, respectively. The downward revisions concern all the Member States under review, suggesting both a common factor and the high level of interconnection of our economies. Nonetheless, growth is expected to remain uneven across Member States.

The outlook has weakened

Over the summer, signs of a more extensive weakening of global demand and world trade emerged. The recovery lost steam in the US, and indicators for world trade suggest a further weakening into the third quarter.

Global output is now projected to grow by some 4% in 2011, a downward revision of about 0.5% compared to the spring forecast. Financial market conditions deteriorated on the back of contagion of the sovereign debt concerns in the euro area and anxiety about the outlook for growth and fiscal sustainability in the US.

GDP growth in the EU in the second half of 2011 is now expected to be subdued, coming to a virtual standstill towards the end of the year. Net exports, which were again the main driver of growth in the second quarter, are set to become less dynamic. Business and consumer survey data have deteriorated sharply since the spring, indicating a weakening of domestic demand in the second half of the year and possibly beyond the horizon of the interim forecast. Ongoing balance-sheet adjustment is likely to contribute to the weakness of domestic demand. Financial market stress is set to dent confidence and increase investment cost.

Inflation is set to ease gradually

Inflation in the EU is now expected to moderate faster than envisaged in spring. It accelerated in the first half of the year, driven mostly by the energy component Commodity prices have, however, recently declined somewhat. With weaker economic growth going forward, HICP inflation in the EU and the euro area is expected to ease gradually, reaching respectively 2.9% and 2.5% for the year as a whole, and remaining above 2% until the end of 2011.

Risk assessment

Uncertainty about the economic outlook remains high. Some of the downside risks considered in the spring forecast have now materialised. In particular, the global economy has slowed down, and hopes that the sovereign debt crisis would gradually dissipate have been disappointed. The risks to growth remain tilted to the downside. Conversely, risks to the inflation outlook have now abated somewhat since spring and are considered as balanced.