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European Commission

Olli REHN

Vice-President of the European Commission and member of the Commission responsible for Economic and Monetary Affairs and the Euro

Autumn Forecast: Gradual recovery, external risks

Autumn Forecast Press Conference, Brussels

5 November, 2013

Welcome to this presentation of our 2013 Autumn Forecast.

In fact, today we mark the 50th anniversary of economic forecasting at the European Commission. Namely, in the autumn of 1963, Member States and colleagues from what is now the Directorate General for Economic and Financial Affairs produced a forecast as the basis for the so-called Comité de politique conjoncturelle to formulate policy recommendations in the preparation of the 1964 national budgets.

Economic forecasting has taken a number of leaps forward since then, and our economic governance has taken a major leap forward in the past couple of years. This autumn, the Commission is for the first time assessing the draft budgetary plans of euro area countries. Next week, based on this forecast largely, I will present to you our first set of opinions on these draft budgetary plans of the euro area member States.

Turning to today's business, our Autumn Forecast shows three broad tendencies.

First, in Europe overall, growth turned positive in the second quarter of this year and confidence has been rising. Domestic demand is gaining strength, including investment. However, the on-going necessary adjustment process will continue to weigh on growth for some time.

Second, for those countries that recorded current account deficits over the last decade, net exports are now contributing more strongly to growth. At the same time, domestic demand is gradually firming in the countries with a current account surplus.

Third, in the global economy, while the emerging market economies have grown fast in recent years, their growth is now expected to slow down, while advanced economies are becoming relatively stronger.

The third point implies that the external environment is somewhat less supportive to EU growth than foreseen in our spring forecast.

Economic activity outside the EU is now expected to grow at 3½% in 2013, clearly below normal average, accelerating to 4% in 2014 and 4¼% in 2015.

This is largely caused by a weakened outlook for a number of emerging market economies. In contrast to recent years, when emerging markets were the main driver of global growth, the relative contribution of advanced economies in the first half of this year was significant and growing.

Moreover, external risks to the forecast have risen and that's why I also included this in the headline of today's presentation.

First, while growth in the US is expected to accelerate over the forecast horizon, with the elevated level of public debt at 105% of GDP, navigating around the next fiscal cliff in February 2014 will require very decisive action by US policymakers to avoid another train wreck that could damage growth both in the U.S. and global economy.

Moreover, the eventual phasing-out of monetary stimulus, likely to start in the U.S: in line with the Fed's revised forward guidance, will call for careful calibration and communication to avoid ramifications to growth.

Second, not only growth in emerging market economies has slowed down, but also the growth models of some countries may have reached their limits. More broadly, the lack of will or ability to deliver reforms that are necessary to strengthen economic fundamentals is a major risk in some emerging market economies. Renewed capital flow volatility, particularly related to the phasing-out of monetary stimulus, could aggravate uncertainly and weigh on growth in the world economy and thus also on Europe.

Let me turn to some better news now. Confidence in Europe is gaining strength. Survey indicators have improved substantially since last spring. They now point to a moderate expansion in economic activity.

Our Economic Sentiment Indicator (ESI) has been showing a steep upward trend since May this year, driven by improving sentiment among managers in all business sectors, to its highest level in more than two years. Manufacturing and services output has expanded since July, even though the observed rise has somewhat moderated in October.

It is encouraging that in vulnerable Member States (Greece, Portugal, Spain and Italy are shown here), confidence has picked up in recent months, although the most recent reading in October has been somewhat disappointing.

In the same vein, confidence has been returning to EU financial markets. In June and July we saw global financial-market volatility, triggered by the announcement of the now postponed "tapering" by the US Federal Reserve. Meanwhile, the stabilisation and normalisation in the sovereign bond markets of vulnerable EU Member States has continued. As a sign of normalisation, benchmark yields such as German Bunds have recently increased, as capital flows into these safe-haven bonds have declined.

The receding stress in sovereign bond markets shows that the extreme risk of a euro break-up, as perceived by markets last year, is no longer present. At the same time, country-specific differences remain, given the different macroeconomic conditions. Recent episodes have shown that markets react to decisive policy action – or doubts about it.

Overall, concerning credit conditions, there are some signs that the contraction in credit growth is slowing down. Divergence in lending conditions and volumes across the euro area has been reduced, but still remains high. This means that financial fragmentation within the euro area prevails.

The latest fresh ECB bank lending survey of October suggests less tight credit standards and a slower decline in demand for both enterprises and households. Looking ahead to the next quarter, euro area banks expect easing credit conditions and rising credit demand.

But the survey-based signals have not yet translated into increased lending to the private sector and to the real economy. Credit to households has grown modestly, which should support domestic demand. However, the credit volume to non-financial corporations or normal businesses has continued to contract over the past few months, as the adjustment in that sector is still going on.

In the second quarter of this year, the European economy returned to positive GDP growth, after six quarters of contraction or stagnation.

After the decline in growth in the first quarter of this year by -0.1% in the EU (-0.2% in the euro area), we saw a rebound in the second quarter by 0.3%. We expect positive but still subdued growth in the second half of this year.

I think it's important to keep in mind that the negative growth rates at the end of last year and in the first quarter of this year pull the annual rate down in terms of average for 2013.

As such, GDP in annual terms is expected to remain unchanged in the EU and contract by 0.4% in the euro area in 2013. This confirms our projection from May this year.

In 2014, economic activity is projected to expand by 1.4% in the EU as a whole and 1.1% in the euro area. We expect a further acceleration in 2015 to 1.9% in the EU and 1.7% in the euro area. As the needs of deleveraging subside, domestic demand is expected to strengthen slowly, thanks to resuming private consumption growth and rebounding investment. Furthermore, improving overall financing conditions and economic sentiment will contribute to the acceleration of economic growth.

After the significant progress in fiscal consolidation achieved over the past three years, its pace has been slowing down. To illustrate how far we have come, at the height of the crisis in 2011, there were only three Member States not in the Excessive Deficit Procedure. Today, there are twelve.

Overall, the nominal deficit-to-GDP ratio in 2013 is forecast to reach 3.5% in the union as a whole and 3.1% in the euro area respectively. For the EU as a whole, nominal deficits should be reduced below the 3% threshold next year and remain below it in 2015.

The pace of deficit reduction in structural terms in both the EU and the euro area is expected to have halved this year compared to 2012. More precisely, the fiscal consolidation in Europe in structural terms amounts to ½% of GDP in 2013 and is expected to decrease further to around ¼% of GDP next year.

The debt-to-GDP ratio is now expected to peak and stabilise in 2014, at about 90% in the EU and 96% in the euro area.

On the back of easing energy price pressures, consumer-price inflation has continued to slow down in the course of 2013.

The forecast projects a broad stabilisation in core inflation at around 1½% in 2014-15, consistent with the expected pace of recovery.

The low inflation rate in the current cyclical phase is largely a symptom of weak demand and part of the internal adjustment that some Member States are going through.

However, as many of you are aware, the most recent data indicate that we will likely see an even lower rate of inflation in the near term.

According to Eurostat's flash estimate for October, which we received after the cut-off date of the forecast, 22 October, euro area annual inflation stood at 0.7%, down from 1.1% in September. Lower food and energy prices played a role, but core inflation (HICP excluding unprocessed food and energy) declined from 1.0% to 0.8%, indicating low and waning underlying price pressures. Thus, it seems that the rate of inflation this year is clearly below the ECB's monetary target.

Before concluding I would like to turn to the economic rebalancing process, which is important, the adjustment process reflects the necessary balance sheet adjustment in the private and public sector. This has been no ordinary cyclical downswing. And it is not an ordinary return to growth, either.

This graph shows the countries that ran a current account surplus and those that ran a deficit in the first decade of monetary union.

On the left hand side, you can see the so-called "surplus" countries (Austria, Belgium, Finland, Germany, Luxembourg, Netherlands). While net exports were contributing most in the low growth years (2012 and still 2013), the contribution from domestic demand to growth is increasing over time.

On the right hand side, you see a group of vulnerable countries that ran current account deficits in the past: Greece, Portugal, Ireland and Spain. The latter three have turned their current account deficit into surplus by now, and the deficit of Greece is forecast to diminish over time. You can see that net exports are playing a significant role as a growth contributor.

Let me conclude with the European growth map for 2014.

Next year all Member States will have moved into positive territory as regards economic growth, with two exceptions. At the same time, the picture will remain varied, ranging from the negative growth in Cyprus and Slovenia to the broad majority of member states for which solid and for some even strong growth is projected, to the already now rapidly growing Baltic states, where growth rates are projected to be 3-4% of GDP.

Let me make some comments on the map by way of a selection of countries as to growth and unemployment. We will deal with public finances next week.

Germany and Austria have subdued growth this year due to a slow beginning, but are accelerating quite solidly next year. Unemployment is low, and in 2014 and 2015 domestic demand is expected to be the main growth driver in both countries.

In France and Belgium, growth will remain weak this year, as investment has been falling, and domestic demand will only gradually lift the growth rate next year. In both countries, unemployment does unfortunately not fall much, also as growth in the labour force is not being absorbed to the labour market.

The Netherlands and Finland are expected to contract this year, though less than in 2012. Next year will bring a muted acceleration in economic activity. Domestic demand remains weak, in the Netherlands due to the adjustment in the housing market, and in Finland, due to the on-going structural change in the industrial sector.

The economies of Italy and Spain will contract this year in annual terms. But for Spain, growth is expected to have returned in the third quarter, and for Italy this is expected in the fourth quarter. In both countries, large needs of adjustment still remain, which in Spain is visible in the unbearably high unemployment rate, though this seems to have been stabilising recently. In particular for Spain, exports have become the growth driver, and both countries have moved their current account into surplus.

Ireland is an early adjuster after the beginning of the financial crisis, and the country has been recording growth above the EU average since 2011 and is expected to continue so going forward. Unemployment has been declining at a steady pace and is expected to continue this encouraging trend. Ireland will exit its economic adjustment programme in December.

Portugal has returned to positive growth in the second quarter of this year, and like in Ireland, exports play an important role in this process. However, while growth is gradually picking up next year, it will only be with a lag until this is reflected in a high rate of employment.

The economy of Greece will still contract this year, but there has been a strong revival of tourism, with positive implications for growth. Led by exports, including tourism, and investment, growth is expected to return in 2014. This is predicated on the full implementation of the programme.

The UK will contribute to growth in Europe with above-average rates as private consumption is strengthening on the back of employment growth. Investment is also expected to rebound from next year on.

Sweden as well is on the path for a domestic demand driven recovery with falling unemployment.

Poland has recorded above average growth throughout the crisis and will continue so on the back of rising private consumption. In Hungary, growth is set to rebound this year. In both countries, the labour market is broadly stagnating over the forecast period.

Estonia, which adopted the euro two years ago, is forecast to grow above average with 3% next year and almost 4% in 2015 and unemployment is on a firmly declining trend. Finally, Latvia is recording very solid growth of 4% annually over the forecast horizon, with unemployment falling rapidly, after the rapid and difficult adjustment under the programme until 2012. I am very much looking forward to welcome Latvia as the 18th member of the euro area in January.

In short, we are seeing clear signs of an economic turnaround, but growth will pick up only gradually and will translate into jobs only with a lag. That's why we cannot yet declare victory, and we must not fall into the trap of complacency. Further decisive action to boost sustainable growth and job creation will continue to be necessary in Europe.

I invite you to meet here next week when the Commission will present the Annual Growth Survey that kick-starts the European Semester 2014, the Alert Mechanism Report for the macroeconomic imbalances procedure and the first euro area wide assessment of draft budgetary plans.

Thank you for your attention.


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