Forecast Update: Growth expected to moderate and increased downside risks
While euro area growth has been slightly more robust than projected in 2007, its prospects now look slightly weaker for 2008. This is due in part to rising oil prices, the impact of the current turmoil on financial markets and the strong appreciation of the euro against the US Dollar. ELNEP now expects GDP to expand by a rate of 2.5% instead of 2.2% for 2007 and 2.0% instead of 2.1% in 2008. Moreover the risks of a more serious economic downturn have increased.
Compared with the forecast made by the ELNEP network in April 2007, the current – mid- October – evaluation of the economic situation in the euro area is ambiguous. On the one hand, euro area growth is currently even slightly more robust than projected in spring, having performed unexpectedly strongly in the first half of 2007. Therefore, the growth forecast for 2007 has been revised upwards, from 2.2% to 2.5%.
|
Key forecast figures for the euro area | |||
|
% change on previous year* | |||
|
2006 |
2007 |
2008 | |
| Gross domestic product |
2.8 (2.6) |
2.5 (2.2) |
2.0 (2.1) |
| Private final consumption expenditure |
1.8 |
1.4 (1.7) |
2.0 (1.9) |
| Government consumption expenditure |
2.1 |
1.9 (1.6) |
1.4 |
| Gross fixed capital formation |
5.3 (4.5) |
4.8 (4.1) |
2.6 (3.3) |
| Net exports of goods and services 1 |
0.2 (0.4) |
0.4 (0.1) |
0.1 |
| Exports 2 |
8.0 (8.4) |
5.6 (5.8) |
4.7 (5.0) |
| Imports 2 |
7.7 (7.8) |
4.8 (5.7) |
4.8 (5.0) |
| Current account balance 3 |
-0.1 (-0.2) |
0.0 (-0.3) |
- 0.3 |
| Employment |
1.4 |
1.3 |
1.0 |
| Unemployment rate 4 |
7.9 (7.8) |
7.0 (7.3) |
6.9 (7.0) |
| Unit labour cost |
0.8 |
1.5 |
1.5 (1.4) |
| Inflation (HICP) |
2.2 |
2.0 (1.8) |
1.9 (1.8) |
| Budget surplus/deficit 3 |
- 1.8 |
-0.9 (-1.2) |
- 0.9 |
|
* Spring estimates/forecast in brackets Source: Eurostat, ECB, OECD, ELNEP forecast. | |||
On the other hand, the outlook for the euro area in 2008 now looks less sound than it did in spring. One major reason is the appreciation of the euro against the US-dollar – a risk scenario of the spring ELNEP forecast that became reality. The strong euro will dampen euro area exports and this might also slow down investment growth. The European currency would be expected to continue to appreciate further if the Fed continues to lower the federal funds rate. An additional damper to growth is the recent rise of the oil price to new highs (in USD), although attenuated by the euro strength. Accordingly, ELNEP now forecasts a slightly weaker expansion for 2008 (2.0% instead of 2.1%).
Moreover, the recent turbulence in financial markets, the magnitude of which is only gradually becoming apparent at the present time, substantially increases the downside risks to the forecast. The deterioration of the US housing market, its effects on US private consumption, and hence a slowdown in US economic growth had been anticipated in the spring forecast. Nevertheless, the ELNEP underestimated the repercussions of US sub-prime mortgage defaults on European (and worldwide) financial markets. The forecast update assumes that current liquidity problems of banks in the wake of US housing market problems will have a limited effect on credit conditions in the euro area. However, a credit crunch due to prolonged liquidity problems and therefore troubled banks constitutes a major downside risk, or even the major downside risk, for the ELNEP forecast.
The effects of such a financial crisis would differ widely between the individual European countries. Countries that ELNEP views as being particularly vulnerable in this aspect are those that have experienced a steep increase in house prices and a construction boom – similarly to the US. Two euro-area countries stand out in this respect: Ireland and Spain. Hence, their growth rates may equally suffer from declining house prices, defaulting mortgage loans in the wake of higher credit rates (90% of Spanish mortgage loans are at flexible rates), and a cooling construction sector.