EU growth forecast for 2021 raised to 4.8%, but with inflation warning

European Union officials markedly raised their outlook for the euro-area economy and said there’s a higher risk of inflation taking hold as loosening virus restrictions allow demand to snap back.

The European Commission increased its growth forecast for the currency bloc to 4.8% from 4.3% previously, while predicting better performance in 2022 too. The economy already did better than initially projected in the first quarter, and recent data suggests a strong rebound in private consumption is already under way, it said.

“The European economy is making a strong comeback,” European Commission Vice President Valdis Dombrovskis said in a statement. “We will have to keep a close eye on rising inflation, which is due not least to stronger domestic and foreign demand.”

The forecasts underscore how concerns about consumer prices are mounting even in the euro zone, where the risk of setbacks to the recovery prompted the European Central Bank to follow an increasingly lonely path with emergency stimulus. Counterparts such as the Federal Reserve are starting to think of winding down such support.

The Commission raised its outlook for inflation and now expects a rate of 1.9% in 2021, compared to 1.7% previously. Rising energy and commodity prices and supply-chain bottlenecks are contributing to price pressures this year, though inflation should slow down again in 2022.

Price growth could turn out more persistent than currently expected if supply-chain problems don’t fade, while increasing production prices could be passed on to consumers and trigger second-round effect, officials said.

ECB policy makers have also said that they’re watching closely for signs of higher wages. Rising oil prices resulting from a fight over supply between exporting countries could lift prices further and add to volatility on financial markets.

 

Risks to the growth outlook were underscored by an unexpected decline in German industrial production reported on Wednesday. The drop in output for May was primarily driven by the auto sector, which continued to suffer from a shortage of semiconductors, the Economy Ministry said in a statement.

Still, the commission said it expects the strong rebound in private consumption and evidence of a revival in intra-EU tourism to “outweigh the adverse impact of the temporary input shortages and rising costs hitting parts of the manufacturing sector.”

Delta Variant

A decline in infections has allowed governments to gradually ease restrictions on the economy, allowing the beleaguered services sector to catch up with manufacturing, which had held up well during the most recent rounds of restrictions.

The spread of the more transmissible delta variant of the coronavirus presents a growing threat though. The Commission cited new strains as a key risk, noting that Portugal already recorded a steep increase in new infections, dominated by the delta variant. ECB President Christine Lagarde cited that last week as weighing on the balance of economic risks.

“This underscores the importance of a further rapid increase in full vaccination,” the commission said in its report. “However, the pace of vaccination rollout may start hitting acceptance constraints.”

An increase in infections could quickly lead to new travel restrictions and particularly hit Europe’s tourism-dependent south, compounding the divergence of economic fortunes in the currency bloc. It would probably also extend the economy’s dependence on fiscal and monetary support.

The recovery is already seen as “highly uneven” within the EU, with Germany and the Netherlands expected to reach pre-crisis levels of output in the third quarter, a full year ahead of Italy and Spain, the Commission said.