R 281147Z JAN 09
FM USEU BRUSSELS
TO SECSTATE WASHDC
DEPT OF TREASURY WASHDC
USDOC WASHDC
INFO EU MEMBER STATES COLLECTIVE

UNCLAS USEU BRUSSELS 000117 
 
 
E.O. 12958:  N/A 
TAGS: ECON EFIN EINV EUN
SUBJECT: EU Commission Forecasts Significant Worsening in EU 
Economy 
 
¶1.  (SBU) Summary: The European Commission released on January 19 
its interim economic forecasts, advancing their release date by a 
full month due to the exceptionally difficult economic 
circumstances. The forecasts recognize that the impact on the real 
economy became more pronounced after the events evolved extremely 
rapidly in the financial markets last year. Europe entered the 
recession in the third quarter of 2008. The recession is expected to 
continue, with a further decline of GDP in the first two quarters of 
2009, as confidence indicators plunged to record lows in December. 
 
Financial crisis is being passed on to the real economy 
--------- ------ -- ----- ------ -- -- --- ---- ------- 
 
¶2.  (SBU) The most recent economic forecasts by the European 
Commission expect GDP to fall sharply (-1.8 pct. in the EU and -1.9 
pct. in the euro area) in 2009, before recovering by about 0.5 pct. 
in 2010. Estimated figures for 2008 put GDP growth at about 1 pct., 
down from 3 pct. in 2007. As a result of the slowdown, unemployment 
figures are expected to rise to 8.7 pct. in the EU in 2009 (and 9.2 
pct. in the euro area), with a further increase in 2010, and 
deficits will also grow in 2009 - from 2 pct. to 4.5 pct. in the EU 
and from some 1.7 pct. to 4 pct. in the euro area. Inflation, on the 
other hand, is set to fall rapidly, from 3.7 pct. in 2008 in the EU 
(3.3 pct. in the euro area) to 1.2 pct. in 2009 (1.0 pct. in the 
euro area) and just below 2 pct. in 2010 in both regions. Global 
growth is also expected to slow to 0.5 pct. in 2009 from 3.3 pct. in 
2008, before starting a moderate recovery during the second d half 
of 2009, reaching an expected 2.7 pct. in 2010., the Commission 
decided to advance by more than one month its interim forecasts. 
 
Investment slows more markedly than demand 
---------- ----- ---- -------- ---- ------ 
 
¶3.  (SBU) The current recession is broad-based and affects all 
demand components except government consumption and public 
investment. Disposable income growth is expected to be adversely 
impacted by higher unemployment and lower wage growth in 2009. In 
addition, concerns about the outlook for the economy could prompt 
households to remain cautious, in spite of lower inflation and 
considerable efforts by governments. Private consumption is 
therefore expected to contract slightly in 2009, and to regain some 
ground only in 2010. Private investment, on the other hand, is 
severely affected by the economic downswing in general, as well as 
by the ongoing housing crises in some economies. Housing investment 
in the euro area is set to fall by about 9 pct. in 2009 and to 
continue shrinking, albeit at a smaller rate, in 2010. A similar 
pattern is expected for investment in machinery and equipment, on 
the back of the current fall in capacity utilization rates and the 
worsening of the outlook for 2009 along with a slight further 
decline in 2010. This also reflects tighter credit conditions 
despite considerable efforts by government and central banks. 
 
Deficit and debt are on the rise 
------- --- ---- --- -- --- ---- 
 
¶4.  (SBU) The economic downturn is having a significant negative 
impact on public finances over the forecast horizon. In 2008, the 
budget deficit in the EU stood at 2.0 pct. of GDP, up from 0.9 pct. 
in 2007. Similarly, in the euro area the deficit rose from 0.6 pct. 
of GDP in 2007 to 1.7 pct. in 2008. A further worsening of fiscal 
balances is foreseen for 2009 and 2010. In 2009, the deficit in the 
EU is projected to rise sharply (+2.5 percentage points) to 4.5 pct. 
of GDP. In the euro area, the deficit is projected to reach 4 pct. 
of GDP. In both areas, this would represent the highest general 
government deficit in almost fifteen years. A further increase by 
almost 0.5 percentage points is foreseen for 2010 in both regions, 
leading to deficits of just below 5 and 4.5 pct. of GDP in the EU 
and the euro area, respectively. 
 
¶5.  (SBU) In the euro area, the budget deficit is set to breach the 
3 pct.-of-GDP reference value in Ireland, Greece, Spain, France, 
Italy, Portugal and Slovenia in 2009, with Ireland experiencing a 
particularly sharp deterioration. 
 
¶6.  (SBU) Outside the euro area, government balances are also 
forecast to see a broad-based deterioration. The downturn, combined 
with expansionary discretionary measures, is projected to widen the 
deficit in the United Kingdom by more than 4 pct. to 8.7 pct. of GDP 
in 2009. 
 
Unemployment rising 
------------ ------ 
 
¶7.  (SBU) After favorable developments during 2005-2007, the labor 
market started to weaken in most Member States in the course of 
¶2008. In the third quarter of 2008, employment in the euro area 
declined by 0.1 pct. from the previous quarter, while it stagnated 
in the EU. The unemployment rate stood at 7.8 pct. in the euro area 
and at 7.2 pct. in the EU in November 2008, up by about 0.5 
percentage points from early 2008 levels. The labor market situation 
is forecast to deteriorate markedly as companies react increasingly 
to reduced demand and tighter financing conditions. Employment is 
expected to contract by more than 1.5 pct. in both the euro area and 
in the EU in 2009. The pace of decline is expected to slow in 2010, 
with employment contracting by around 0.5 pct. in both areas. As a 
result, the unemployment rate is forecast to increase by close to 3 
percentage points from the lows of early 2008, averaging 10.2 pct. 
in 2010 in the euro area and 9.5 pct. in the EU. 
 
Inflation falling 
--------- ------- 
 
¶8.  (SBU) The recent fall in commodity prices and inflation, which 
should lend support to real household disposable income and cushion 
the fall in household consumption, is one of the few positive data 
points. Euro-area inflation has remained above 3 pct. until October 
2008, peaked in June - July at 4 pct., and has been more than 
halved, reaching 1.6 pct., in December. Looking forward, inflation 
in the euro area is now expected to come down rapidly and bottom out 
at 0.5 pct. in the third quarter of 2009. By end-2009, inflation is 
set to rebound to 2 pct. and stabilize thereafter at 1.7 pct.. The 
reasons are to be found particularly in the further and substantial 
worsening of the economic outlook for both the euro area and the 
global economy. This is already putting substantial downward 
pressure on commodity prices and should also curb wage growth. 
 
¶9.  (SBU) The economic situation and outlook for the EU are 
unprecedentedly uncertain. While many of the downside risks to the 
growth outlook that were identified in the autumn forecasts have 
begun to materialize, leading to the significant downward revision 
in the current baseline projection. However, with the pronounced 
deterioration in growth prospects compared with the autumn and 
taking into account the various rescue and recovery packages, the 
Commission's forecasts considers the risks to the growth and 
inflation outlook to be broadly balanced at the current juncture. 
 
 
MURRAY