Economic outlook for the Euro area in 2009 and 2010

Abstract

· For much of 2009, falling external demand will be the main drag on production in the euro area, with exports expected to decrease by about 13% in 2009. At the same time, the structural problems of the financial sector, combined with the uncertainty on future economic perspectives, will continue to impede investment, which will be reduced by about 6% in 2009. · Consumers will benefit from the increase in real wages that started in the summer of 2008 and will – due to the slow reaction of wage setting to the business cycle in most European countries – continue for the year 2009. Thus, private consumption will, albeit shrinking modestly (-0.6%) because of rising unemployment, be a stabilizing factor for the economy in the euro area. A positive contribution will also come from public consumption, whose growth is forecasted at 1% for 2009 and 0.5% for 2010. · Overall, we expect GDP in the euro area to shrink by 2.8% in 2009, with a modest increase of 0.4% in 2010. This forecast is subject to substantial uncertainty, the interval forecast for growth in 2009 ranges from -3.6% to -2.1%, and it is conditional on a tentative stabilization of financial markets and the real sector, since governments will continue supporting ailing institutions. One major risk factor is that some euro area countries might no longer be able to do so, due to budgetary and debt problems. · Industrial production in the euro area will fall sharply during both 2009 and 2010. The average decline will be of 16.3% and 3.2% respectively. Investment, intermediate and durable consumer goods are mainly responsible for this slump. · Consumer prices in the Euro Area are showing somewhat more stability than in the US. HICP inflation is expected to fall to 0.5% during this year, but to increase to around 1.9% in 2010. The risk of deflation for the Euro Area economy is negligible. The core inflation index, which does not include energy and unprocessed food, will be around 1.6% during both years. · The expected paths for growth and inflation leave room for the ECB to further cut interest rates. However, the inflationary consequences of more aggressive policies, such as quantitative easing, could be worrying.