Eurozone inflation to fall faster than expected, EU says

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Eurozone inflation is expected to fall faster than previously expected this year as the impact of the Red Sea trade disruption will be softer than expected, according to updated EU estimates.

The European Commission said on Wednesday that annual inflation in the single currency bloc will fall to 2.5 percent this year, before reaching the European Central Bank’s target of 2 percent in the second half of 2025.

In its previous forecast in February, the commission predicted a more gradual decline to 2.7 percent in 2024 and 2.2 percent the following year.

The commission still expects the single currency bloc to grow by 0.8 percent this year, but forecast slightly stronger growth for the European Union of 1 percent in 2024, up 0.1 percent from previous estimates. Last year, growth was 0.4 percent for both areas.

We believe we have turned a corner, said Paolo Gentiloni, the EU’s economy commissioner. We expect a pick-up in growth this year and further acceleration in 2025. Meanwhile, inflation is set to fall further and reach the ECB’s target next year.

Bar graph of the European Commission's Eurozone inflation forecasts (%) showing that Eurozone inflation is now expected to fall faster than previously forecast

In its spring forecast, the commission said the faster-than-expected fall in inflation was due to a weakening in commodity prices, largely due to a softer-than-expected impact of the Red Sea trade disruptions.

The Eurozone economy showed signs of a tentative recovery in the first three months of this year, when its gross domestic product rose 0.3 percent from the previous quarter.

This was driven by higher exports, increased tourism and increased consumer spending as inflation fell.

Economic growth is expected to continue to pick up this year and next, especially as the European Central Bank is widely expected to start cutting interest rates from next month. Inflation is expected to fall further, while wages continue to rise, increasing household spending power.

The following graph of the harmonized index of consumer prices (annual change %) showing that Eurozone inflation has been returning to its target

However, Europe’s economy has been slower than other regions to recover from the pandemic and was hit harder by the fallout from Russia’s invasion of Ukraine. Growth in the region is expected to remain weaker than the US and China.

Gentiloni warned that growth growth was very moderate and subject to downside risks linked to an uncertain and risky geopolitical environment.

Many European countries still face poor productivity per hour worked, as well as low levels of investment, high energy costs, aging populations, a shrinking workforce and reduced working hours.

Germany, whose economy shrank by 0.3 percent last year, is expected to grow by 0.1 percent this year. Nine other EU economies that contracted in 2023 are forecast to return to positive territory.

The EU as a whole, including non-euro countries, is expected to grow by 1 percent this year, up 0.1 percent from previous estimates. Growth in the bloc is expected to reach 1.6 percent next year.

Fiscal policy is also weighing on European growth as many governments in the region are reducing their spending in response to the rollback of EU fiscal rules that limit budget deficits and debt.

It’s not all doom and gloom in Europe, recovery is coming, Alfred Kammer, the IMF’s European director, said this week. But there are challenges and there is no room for complacency, he said, adding that growth in the Eurozone will remain insufficient.

The IMF has called on Europe to remove barriers to internal trade and deepen the integration of its capital markets to boost financing for high-growth firms, as well as invest in green energy, defense and digitalisation. .

ECB executive board member Isabel Schnabel said at an event in Berlin that the eurozone’s increasingly weak ability to generate growth was hampering its international competitiveness.

A noticeable gap has opened up in real IT-related capital stocks between the Eurozone and the US, she said.

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