Overview

Economic growth is projected to remain strong over the next three years despite some headwinds in the near term.^[1] Sharply rising rates of coronavirus (COVID-19) infections in several euro area countries have led to a renewal of restrictions and heightened uncertainty about the duration of the pandemic. The emergence of the Omicron variant has added to this uncertainty.^[2] In addition, supply bottlenecks have intensified and are now expected to last longer, only gradually dissipating from the second quarter of 2022 and fully unwinding by 2023. Real GDP is now expected to exceed its pre-crisis level in the first quarter of 2022, which is one quarter later than foreseen in the September 2021 projections. Nevertheless, as global supply constraints ease, the pandemic-related restrictions and associated uncertainty decrease and inflation abates from high levels, growth is expected to regain momentum from mid-2022, notwithstanding a less supportive fiscal stance and higher market interest rate expectations. Private consumption will remain the key driver of economic growth, benefiting from a rebound in real disposable income, some unwinding of the accumulated savings and a robust labour market, with the unemployment rate at the end of the projection horizon lower than observed at any time since the euro area was established in 1999. Compared with the September 2021 projections, the intensified global supply bottlenecks and tighter pandemic-related restrictions have led to a downward revision to growth in the short term. At the same time, the gradual dissipation of these headwinds should support a stronger bounce-back from the second quarter of 2022 leading to real GDP rising above the level foreseen in the September 2021 projections by the end of 2022, with carry-over effects resulting in a significant upward revision to annual growth in 2023.

Inflation is expected to be higher for longer but should fall slightly below 2% by the end of 2022 and stand at 1.8% in 2023 and 2024. Price pressures have increased significantly over recent months and inflation is expected to have peaked in the fourth quarter of 2021. Although considerably stronger than previously expected, these pressures are still assessed to be largely temporary, reflecting a surge in energy prices and international and domestic mismatches in demand and supply as economies reopen. Energy inflation is expected to remain elevated on average in 2022 but to moderate sharply during the course of the year as downward base effects are reinforced by an assumed decline in oil, gas and electricity prices. In 2023 and 2024 the contribution of the energy component to inflation is expected to be low. HICP inflation excluding energy and food is projected to decline in the course of 2022 as supply bottlenecks gradually ease. Thereafter, it is expected to increase gradually – while still remaining below 2% – as the economic recovery progresses, slack is absorbed and labour costs increase, supported in addition by higher inflation expectations. Compared with the September 2021 projections, headline inflation has been revised strongly upwards, especially in 2022. This reflects recent data surprises; greater upward direct and indirect effects from higher energy commodity prices; a depreciation of the euro exchange rate; more persistent upward pressures from supply disruptions; and robust wage growth.

1 Real economy

Real GDP growth remained strong in the third quarter of 2021, close to the rate foreseen in the September 2021 projections. The ongoing rebound in growth has been driven primarily by domestic demand, notably for consumer services, as a result of high vaccination rates, the associated reduced fear of infection and the easing of pandemic-related restrictions. It has also been boosted by a pick-up in real disposable income and a substantial decline in the saving ratio. In the third quarter the services-led growth more than compensated for the increasing importance of supply bottlenecks as a factor constraining industrial activity.

Real GDP growth is expected to be weak in the near term as pandemic-related restrictions tighten and supply bottlenecks intensify (Chart 1). The renewed intensification of the COVID-19 pandemic has led to a tightening of restrictions since the beginning of the fourth quarter of 2021 and a reduction in mobility in recent months. These tighter restrictions are expected to be maintained over the turn of the year. Mobility should gradually return to pre-pandemic levels from the second quarter of 2022 as the pandemic is expected to loosen its grip on the euro area. The significant moderation in economic growth at the turn of the year is confirmed by the available data releases and survey evidence. For example, retail sales in October stood just 0.2% above their level in the third quarter and the composite output Purchasing Managers’ Index (PMI) stood on average in October and November clearly below its average level in the third quarter. At the same time, manufacturing supply bottlenecks remained severe up to November, with an ongoing lengthening of suppliers’ delivery times as indicated by the respective PMI index. Real GDP growth has therefore been revised sharply down for the last quarter of 2021 and the first quarter of 2022. This reflects the stricter pandemic-related restrictions relative to the assumption in the September 2021 projections, on account of the spread of the Delta variant in many countries and, to a lesser extent, concerns about the Omicron variant, as well as the stronger headwinds from supply bottlenecks.

Global supply bottlenecks have been a significant constraint on euro area industrial production and goods trade in the course of 2021, and are expected to last longer.^[3] As the economic recovery strengthened in the spring and summer of 2021, global shipping disruptions and input shortages prevented euro area firms from increasing their production in line with the rapid growth in demand for manufactured goods. The imbalance at the global level between strong demand and supply shortages has intensified more than previously assumed, affecting more countries and sectors (see also Box 2). Countries with larger shares of sectors that are more integrated into global value chains tend to be more affected by shortages of materials and equipment. The supply bottlenecks are now expected to last longer than assumed in the September projections, only gradually dissipating from the second quarter of 2022 and fully unwinding by 2023. This is in line with recent survey evidence suggesting that the impact of supply bottlenecks could last well into 2022.

After the near-term weakness, growth is projected to pick up strongly from the second quarter of 2022 before slowing down in 2023-24 towards historical average rates. The expected rebound beyond the short term is based on the assumption of a gradual resolution of the COVID-19 pandemic and a decline in its economic impact which should reduce the related uncertainty and strengthen confidence. Moreover, it is based on a gradual unwinding of supply bottlenecks from the second quarter of 2022; continued favourable financing conditions; some unwinding of the high level of accumulated savings; and the ongoing global recovery. In 2023-24 real GDP growth is expected to return to more moderate rates. Although the Next Generation EU (NGEU) programme is expected to boost investment in some countries, the contribution of other fiscal policies is projected to decline compared with 2021, despite being somewhat stronger than that embedded in the September 2021 projections. Real GDP is projected to exceed its pre-crisis level in the first quarter of 2022 – one quarter later than foreseen in the September 2021 projections. However, the upward revision to growth from the second quarter of 2022 brings the level of GDP above that foreseen in the September exercise by the end of 2022 and just slightly below the level expected in the pre-crisis projections (Chart 2).

Private consumption is expected to grow strongly over the projection horizon, notwithstanding a likely slowdown in the near term. Private consumption recovered more strongly than expected in the second and third quarters of 2021, but it still stood 2.4% below its pre-pandemic level in the third quarter. The upward surprise largely reflected a somewhat faster than expected decline in the household saving ratio. Household disposable income continued to be mostly driven by labour compensation, which typically entails a relatively high marginal propensity to consume. Private consumption growth is expected to decrease sharply in the near term as pandemic-related restrictions are tightened and high energy prices weigh on households’ purchasing power. Looking beyond the short term, given the assumed continued resolution of the health crisis in 2022, private consumption growth is projected to strengthen significantly in the second quarter of 2022 and to exceed its pre-crisis level in the third quarter. It should continue to outstrip the path of real income growth in 2023, as the expected dissipation of uncertainty will allow for some unwinding of accumulated excess savings. In 2024 both consumption dynamics and the saving ratio are projected to be close to their historical average levels.

Following a modest decline in the short term, real disposable income is expected to resume its upward path, supported by a rebound in labour income. Following positive growth rates in the second and third quarters of 2021, real disposable income will likely decline, albeit modestly, at the turn of the year, affected by the strong rise in inflation. It is expected to increase thereafter, reflecting the rebound in labour income as the economic recovery proceeds. In contrast, following a strong positive contribution in 2020, net fiscal transfers will weigh on income growth from 2021, as the number of people in job retention schemes decreases and other temporary pandemic-related fiscal measures expire, despite new measures to compensate for the impact of high energy prices.

The household saving ratio is expected to decline to below its pre-crisis level, before stabilising towards the end of the projection horizon. Following its recent steep drop, the saving ratio is expected to continue to fall throughout 2022. This fall is being driven by diminishing forced savings, amid high vaccination rates and an assumed relaxation of pandemic-related restrictions after the winter, as well as a reduction in precautionary savings on account of improving labour markets and fading uncertainty. After falling below its pre-crisis level in the course of 2022, the saving ratio is expected to continue to decline until mid-2023, and then to stabilise close to its historical average level in 2024. The temporary undershooting reflects some unwinding of the excess household savings which have accumulated since the start of the pandemic, supporting vigorous consumption growth. However, this effect is attenuated by the concentration of excess savings in wealthier and older households with a lower propensity to consume.^[4]

The momentum in housing investment is expected to moderate over the projection horizon. Housing investment declined somewhat in the third quarter of 2021 mainly owing to supply constraints. Despite ongoing supply bottlenecks and uncertainty related to the worsening pandemic situation, resilient demand, supported by favourable financing conditions, should contribute to a pick-up in housing investment in the fourth quarter of 2021. Thereafter, continued support should stem from positive Tobin’s Q effects, rising disposable income, improving consumer confidence and the large stock of accumulated savings. Housing investment is expected to catch up with its pre-crisis trajectory by the end of 2022, before its momentum normalises during the remainder of the projection horizon.

Business investment is expected to recover substantially over the projection horizon and to account for an increasing proportion of real GDP. The rebound in business investment seen in the first half of 2021 is expected to be temporarily slowed down by supply-side bottlenecks in the second half of 2021. It is projected to resume its recovery thereafter as supply constraints gradually diminish, global and domestic demand recover and profit growth improves, supported in addition by favourable financing conditions and the positive impact of the NGEU programme. Expenditures related to digitalisation as well as the low carbon transition (including in the car industry owing to environmental regulations and the transition to electric vehicle production) are expected to provide an additional boost to business investment in the medium term. As a result, business investment should account for an increasing share of real GDP over the projection horizon.

Supply bottlenecks are expected to weigh on euro area export market shares until mid-2022, after which these should unwind, resulting in strong gains. Export market shares in 2021 have been driven by two separate developments: first, the impact of supply bottlenecks starting at the beginning of the year and further intensifying in the third quarter, and, second, the recovery in services exports in the second and third quarters. While suppliers’ delivery times have remained elevated and shipping costs have flattened at record levels, the bottlenecks are assumed to persist until they gradually dissipate in the course of 2022. Services trade, and in particular tourism, recovered strongly during the summer owing to seasonality and progress in the vaccination campaigns. However, the resurgence in COVID-19 cases in several euro area countries in the fourth quarter has led to a dampening of confidence in the tourism sector, pointing to another bleak winter season for major travel destinations. With the dissipation of bottlenecks and an easing of travel restrictions by the middle of next year, the pace of the recovery in exports is expected to increase again. The unwinding of global supply bottlenecks is projected to have a positive impact on euro area foreign demand (Box 2) and the recent depreciation of the euro should improve export competitiveness. The pace of import growth should increase again in 2022 and 2023 as domestic demand recovers, but should normalise towards the end of the projection horizon owing to the fading-out of pent-up demand. All in all, net exports are expected to provide a strong positive contribution to real GDP growth in the second half of 2022 before gradually declining to a slightly positive contribution as the effects of the euro depreciation fade out.

The unemployment rate continued to decline in the third quarter of 2021 and is expected to decrease further as the recovery gains pace. A stronger than expected expansion in employment growth in the third quarter of 2021, accompanied by a sharp decline in the number of workers in job retention schemes, underlies the strength of the labour market and the decline in the unemployment rate. The recent increase in job vacancies, coupled with strong employment growth, signals that labour as a factor limiting production remains a sector-specific issue which is being driven by hiring backlogs in the sectors most affected by the pandemic. As the situation in the labour market is likely to improve further, the unemployment rate is projected to fall to its pre-pandemic level by the end of 2021 and to reach 6.6% in 2024, driven by the projected strong labour demand in line with the ongoing economic recovery, but also affected by demographic developments.^[6] Such an unemployment rate would be lower than observed at any time since the euro area was established in 1999.

Labour productivity growth is expected to be temporarily affected by the short-term slowdown in economic growth before regaining momentum. Labour productivity growth increased by 1.2% in the third quarter of 2021, after 1.4% in the second quarter. The slowdown in economic growth related to supply bottlenecks and the renewed intensification of the pandemic implies a sharp decline in productivity at the turn of the year. From mid-2022 labour productivity is expected to regain momentum, following the strengthening of economic growth. By the end of the projection horizon, labour productivity (per person employed) is expected to be around 4½% above its pre-crisis level.

Compared with the September 2021 projections, real GDP growth has been revised down for 2022 and up for 2023. The downward revision to the short-term outlook, reflecting some further tightening of supply constraints, higher energy prices and stricter pandemic-related restrictions, has a negative carry-over effect on annual real GDP growth in 2022. On the back of the expected resolution of the pandemic and the gradual unwinding of supply bottlenecks, quarterly growth has been revised up from the second quarter of 2022, resulting in an upward revision to annual real GDP growth for 2023. A smaller fiscal tightening and an effective depreciation of the euro since the September 2021 projections contributed to the upward revisions, although these factors were partly offset by the negative impact of higher oil prices, weaker foreign demand and higher long-term interest rates.

2 Fiscal outlook

The withdrawal of fiscal support measures is expected to start in 2022 and to continue in 2023-24. After the strong expansion in 2020, the euro area fiscal stance adjusted for NGEU grants is projected to turn broadly neutral in 2021 and to tighten considerably in 2022 and to a lesser extent over the rest of the projection horizon. The tightening of the fiscal stance in 2022 is related to the reversal of a significant part of the pandemic emergency support. Compared with the September 2021 projections, the fiscal stance has tightened significantly for 2021, mostly on account of revenue windfalls and other factors, which often manifest during a recovery and a lower estimate (by about ½ percentage point of GDP) of the overall discretionary stimulus measures. For 2022, the fiscal stance is expected to be around 1 percentage point of GDP looser than expected in the September 2021 projections. This reflects mainly the adoption of new pandemic-related measures, or the extension and re-evaluation of existing measures, as well as new measures compensating for higher energy prices, further social transfers and reductions in direct taxes and social security contributions. Only slight revisions have been made to the fiscal stance for 2023.

The euro area budget balance is projected to improve steadily, particularly in 2022, while remaining below the pre-crisis level at the end of the projection horizon. The euro area budget deficit is estimated to have remained high in 2021, after having peaked in 2020. Over the projection horizon the substantial improvement in the budget balance is driven mainly by the cyclical component and the lower cyclically adjusted primary deficit. Interest payments also contribute to this trend and are projected to continue declining to 1.0% of GDP in 2024. At the end of the projection horizon the budget balance (at -1.8% of GDP) is foreseen to be still below the pre-crisis level. After the sharp increase in 2020, euro area aggregate government debt is expected to decline over the entire projection horizon, reaching about 90% of GDP in 2024, which is above its pre-pandemic level. The decline is mainly due to favourable interest rate-growth differentials, but also to deficit-debt adjustments, which together more than offset the persisting, albeit decreasing, primary deficits. Compared with the September 2021 projections, the fiscal outlook for 2021 has improved, mainly on account of the developments in the fiscal stance. The outlook for 2022-23 remains broadly unchanged, with a slight deterioration in 2022 which mainly reflects the additional stimulus measures added to the baseline in 2022 and other non-discretionary factors. The path of the euro area aggregate debt ratio has been revised downwards over the entire projection horizon on account of favourable revisions to the interest rate-growth differentials, stemming mainly from revisions to nominal growth, and base effects from 2020. Interest payments remain broadly unchanged compared with the September 2021 projections at the euro area aggregate level.

3 Prices and costs

Having reached 4.9% in November 2021, HICP inflation is projected to decrease sharply during the course of 2022 (Chart 3). High energy prices (for transport fuels, electricity and gas), stronger demand in the context of the reopening of the economy, and increasing producer prices as a result of global supply bottlenecks and higher transport costs have led to a strong surge in inflationary pressures, which are also expected to sustain inflation into 2022. However, HICP inflation is expected to decline in 2022 mainly owing to base effects in both the energy and non-energy components, partly related to the reversal of the temporary cut in the German VAT rate in January 2021.^[7] HICP energy inflation is expected to have peaked at the end of 2021, driven by higher fuel prices and gas and electricity tariffs (see Box 3 for more details). These tariffs should continue to increase up to the beginning of 2022. Energy inflation will decrease in 2022 mainly owing to base effects combined with the impact of prices for oil and for wholesale gas and electricity, which are assumed to decline in line with futures prices. HICP inflation excluding energy and food is also likely to decline from its peak in late 2021, partly as a result of base effects, but also as price pressures ease on account of the assumed gradual resolution of supply bottlenecks starting in the second quarter of 2022, while indirect effects from surging energy prices could exert upward pressure. In contrast, food inflation is expected to remain elevated in the coming quarters.

HICP inflation is expected to be stable at 1.8% in both 2023 and 2024. This conceals a slight increase in the HICP excluding food and energy (from 1.7% to 1.8%), while food inflation and energy inflation are foreseen to decline in line with the downward-sloping profile of the oil price futures curve and a declining impact of fiscal measures. HICP inflation excluding energy and food is projected to gradually strengthen over the latter part of the projection horizon, supported by a tightening in product markets, increasing unit labour cost growth and higher inflation expectations, which have been moving closer to the ECB’s inflation target of 2%. In particular, the expected tightening in the labour market should support wage growth and push up HICP inflation excluding energy and food in 2023-24.

Growth in compensation per employee is expected to be still distorted by the take-up of job retention schemes in 2022, but to remain robust thereafter. Growth in compensation per employee has been subject to large swings in the presence of job retention schemes safeguarding employment. This pushed down the annual growth rate of compensation per employee in 2020 and caused a subsequent rebound in the first three quarters of 2021. This impact is expected to persist into the first half of 2022, leading to only a slight reduction in the annual average growth rate from 4.2% in 2021 to 3.8% in 2022. Thereafter, wage growth is expected to ease but to remain robust at 2.9% in both 2023 and 2024. Robust wage growth in the later years of the projection horizon is mainly related to tightness in the labour market, with the unemployment rate expected to fall to historic lows, while second-round effects from the current high level of inflation on wage growth are projected to remain contained in line with the low prevalence of formal wage indexation schemes in the euro area.^[8] Some minimum wage increases are expected over the whole projection horizon, but particularly in 2022. Such increases will lead to a direct mechanical impact of minimum wages on aggregate wage growth but could also have spillover effects on the whole wage structure.^[9] Wage growth in the public sector is projected to be consistently below that in the private sector – suggesting that any positive spillovers from the public to the private sector are unlikely.

Unit labour costs are expected to increase over the projection horizon, driven by slower growth in productivity per person employed and robust wage growth. As the impact of job retention schemes fades, the decline in the growth of compensation per employee between 2022 and 2023 is expected to be matched by a similar decline in labour productivity per person employed, leading to unit labour cost growth of around 1% in both 2022 and 2023. However, the continued normalisation of labour productivity growth in 2024, combined with continued robust wage growth implies a notable increase in unit labour costs which will contribute to the uptick in HICP inflation excluding food and energy.

External price pressures are expected to be significantly stronger than domestic price pressures in 2022 but to drop to considerably lower levels in the later years of the projection horizon. The annual growth rate of the import deflator is expected to rise from -2.6% in 2020 to 6.7% in 2021, largely reflecting increases in oil and non-energy commodity prices but also some increases in input costs related to supply shortages and the depreciation of the euro. From 2022 import price growth is expected to moderate and stand at 0.8% in 2024.

Compared with the September 2021 projections, the outlook for HICP inflation has been revised upwards by 0.4 percentage points for 2021, 1.5 percentage points for 2022 and 0.3 percentage points for 2023. Just over half of the cumulated revision relates to the HICP energy component (mainly concentrated in 2022), just under one-third relates to HICP inflation excluding food and energy and the rest relates to the HICP food component. These revisions reflect recent upward data surprises, higher upward direct and indirect effects from the recent surge in energy commodity prices, stronger and more persistent upward pressures from supply disruptions, stronger wage growth and a depreciation of the euro exchange rate.