Europe's economy settling down but facing challenges in 2023

Introduction After three years of pandemic shutdowns, reopening booms, war, clogged supply chains and nascent inflation, European policymakers thought that 2023 would be the year the old continent returned to a new normal of decent growth and sub-2% inflation. However, the new normal is considerably uglier than economists had expected.

Positive Developments

• Euro zone has proved remarkably resilient, considering the shock of Russia’s invasion of Ukraine and the energy crisis.

• Headline inflation, having reached a record 10.6% in October, is falling.

• Industry has not collapsed because of the cost of fuel.

• According to the European Commission’s latest forecast, the bloc will avoid a contraction this quarter.

Employment and Consumption

• The number of people employed across the bloc rose again in the fourth quarter of 2022.

• Unemployment rate is at its lowest since the euro came into existence in 1999.

• Consumption contributed half a percentage point to quarterly growth in the second and third quarters of 2022.

• Households began to tighten their purse strings in the fourth quarter of 2022.

• Consumption could become a problem as state handouts and price caps will be withdrawn this year.

Inflation

• Inflation is proving stubborn and wholesale energy prices are passed on to consumers in different ways across the EU, making forecasting difficult.

• High prices and labor shortages are pushing up pay demands, which could add to inflation.

• Wages in the euro zone tend to follow underlying, or “core”, inflation.

• The consumer-price index, excluding food and energy, rose by 7% in the year to January.

• Services, in particular, face steeply rising costs, according to the pmi survey, which may lead to further price increases.

Challenges

• Europe's strong jobs market could add to inflation.

• The European Central Bank is expected to keep interest rates high.

• Credit standards are already tightening, according to the bank’s lending survey.

• The euro zone's prospects for growth in 2023 are not optimistic.

Conclusion The euro zone may have escaped recession so far, but its prospects—stubborn core inflation, high interest rates and a weak economy—are hardly pleasant. The imf predicts 0.7% growth in 2023; the commission forecasts 0.9%. Even this might be optimistic. America faces equally stubborn inflation, and China’s reopening has not provided much of a boost to the bloc. Welcome to the grim new normal.