Eurozone inflation to fall faster than expected, EU says

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Eurozone 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.

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.

“The faster than expected decline in inflation is due to a weakening in prices for goods, largely due to milder than feared impact on Red Sea trade disruptions,” the commission said.

The commission maintained 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.

Paolo Gentiloni, the EU’s economy commissioner, warned the uptick in growth is “very moderate” and subject to downside risks linked to an “uncertain, dangerous” geopolitical environment.

Line chart of Harmonised index of consumer prices (annual % change) showing Eurozone inflation has been falling back towards its target

The Eurozone 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.

This was boosted by higher exports, increased tourism and a rise in consumer spending as inflation fell.

Economic growth is set to keep increasing this year and next, especially as the European Central Bank is widely expected to start cutting interest rates from next month. 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 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.

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 economies that contracted in 2023 are projected to return to positive territory.

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 limiting budget deficits and debt.

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

The IMF has called for Europe to remove barriers to internal trade and to deepen integration of its capital markets to boost funding for high-growth firms, as well as investing in green energy, defence and digitalisation.

ECB executive board member Isabel Schnabel told an event in Berlin that the Eurozone’s “increasingly poor” ability to generate growth was hampering its international competitiveness.

“A glaring gap has opened up in IT-related real capital stocks between the Eurozone and the US,” she said.

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