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Euro zone inflation to fall faster than expected, EU says

Revised figure comes as impact of Red Sea trade disruption proves milder than expected

A ship transits the Suez Canal towards the Red Sea. Euro zone inflation is set to drop faster than previously expected this year as the impact of Red Sea trade disruption proves milder than expected, according to updated EU estimates. Photograph: Sayed Hassan/Getty Images

Paola Tamma and Martin Arnold
Wed May 15 2024 - 10:37

Euro zone inflation is set to drop faster than previously expected this year as the impact of Red Sea trade disruption proves milder than expected, according to updated European Union estimates.

The European Commission on Wednesday said annual inflation in the single currency bloc is set to drop to 2.5 per cent this year, before reaching the European Central Bank’s 2 per cent target in the second half of 2025.

In its previous forecast in February, the commission projected a more gradual decrease to 2.7 per cent in 2024 and 2.2 per cent next year.

“An acceleration [in economic activity] is taking place, in an environment where inflation is going down, so we expect a possible increase of private consumption and the situation of the labour market remains quite strong,” said EU economy commissioner Paolo Gentiloni on Monday.

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The commission said its earlier projection for the single currency bloc to grow by 0.8 per cent this year, before reaching 1.4 per cent in 2025. Last year, growth was 0.4 per cent.

Mr Gentiloni warned the uptick in growth is “very moderate” and subject to downside risks linked to an “uncertain, dangerous” geopolitical environment.

[ Latest euro zone inflation figures suggest ECB will move slowly on rates ]

The euro zone economy showed signs of a tentative recovery in the first three months of this year when its gross domestic product rose 0.3 per cent from the previous quarter, boosted by higher exports, increased tourism and an uptick in consumer spending after inflation fell.

Economic growth is set to keep picking up this year and in 2025, especially as the European Central Bank (ECB) is widely expected to start cutting interest rates from next month and inflation is forecast to fall further while wages keep rising – boosting household spending power.

However, Europe’s economy has been slower than other regions to rebound from the impact of 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.

Many European countries are still faced with weak productivity – output per hour worked – as well as low levels of investment, high energy costs, ageing populations, shrinking workforces and falling working hours.

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Germany, whose economy contracted by 0.3 per cent last year, is expected to grow by 0.1 per cent this year. Another nine EU countries that experienced contractions in 2023 are projected to return to positive territory. Only Estonia is set to contract further, by 0.5 per cent.

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

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

“It is not just doom and gloom in Europe – the recovery is coming”, Alfred Kammer, European director of the International Monetary Fund (IMF), said this week. “But there are challenges and there is no room for complacency”, he said, adding that growth in the euro zone would remain “insufficient”.

[ Euro zone exits recession but inflation remains sticky ]

The IMF has called for Europe to remove barriers to internal trade between EU countries and to deepen integration of the union’s capital markets to boost funding for high-growth firms and to make the necessary investments in green energy, defence and digitalisation.

ECB executive board member Isabel Schnabel told an event arranged by the German chancellor’s office in Berlin that the euro zone’s “increasingly poor” ability to generate sustainable growth was hampering its international competitiveness.

Warning that “a glaring gap has opened up in IT-related real capital stocks between the euro zone and the US”, Ms Schnabel called for “measures to strengthen competition, reduce bureaucracy and promote further integration of goods, labour and financial markets”. – Copyright The Financial Times Limited 2024

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