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Gradual economic recovery in progress in the EU

The commission's spring forecast confirms that the economic recovery is in progress in the EU. After having experienced the deepest recession in its history, the EU economy is set to grow by 1% in 2010 and 1,75% in 2011. This implies an upward revision of one-fourth percentage point for this year from the commission's autumn forecast, as the EU countries benefit from a stronger external environment. Nevertheless, weak domestic demand continues to restrain the recovery further out.

The speed of recovery is forecast varies across Member States, reflecting their individual circumstances and the policies they pursue. Labor market conditions have shown some signs of stabilization recently, with the unemployment rate projected to peak this year at a lower level than forecast earlier, yet at close to 10% in the EU. The temporary fiscal measures put in place have been key in turning the EU economy around, but also added to the public deficit, which is set to rise to 7,25% of GDP in 2010, before falling back slightly in 2011.

EU commissioner for Economic and Monetary Affairs, Olli Rehn, said: "The improved outlook for economic growth this year is good news for Europe. We must now ensure that growth will not be derailed by risks related to financial stability. Sustainable growth calls for determined fiscal consolidation efforts and reforms that enhance productivity and employment."

The economic recession came to an end in the EU in the third quarter of 2009, in large part thanks to the exceptional crisis measures put in place under the European Economic Recovery Plan, but also owing to some other temporary factors. Beyond the initial rebound, the recovery is proving more gradual than in past upturns. This is not surprising given the extraordinary nature of the recent downturn. Cyclical rebounds following financial crises tend to be more muted than in other circumstances. Like other developed countries, the EU will grapple with the legacy of the crisis for some time to come.

Gradual post-crisis recovery ahead

Although the near-term growth prospects remain subdued on the whole, a modest improvement is foreseen compared to the autumn forecast. This follows from the stronger rebound in global activity and trade at the turn of the year and an improved external outlook. Further out, the EU economy faces headwinds on several fronts that are set to hold back demand. The profile of this recovery is likely to be affected, to some extent, by a number of temporary factors, whether weather-related, cyclical or policy-induced.

With the fading-out of these effects, GDP growth is expected to regain ground more firmly by the end of 2010 only. This follows from the still very low level of capacity utilization, de-leveraging and heightened risk aversion that hold back investment, and subdued private consumption growth Consumption growth is also constrained by weak wage and employment growth, and in a number of countries by the housing market correction.

Labor market and public finances under pressure

Although substantial, the impact of the economic crisis on the EU labor market seems somewhat smaller than initially expected. This is explained by the use of short-term measures and labor hoarding in some Member States, but is also a result of past reforms. Signs of stabilization have recently begun to emerge and the outlook is now somewhat improved compared to the autumn forecast. Nevertheless, reflecting the usual lag between developments in the real economy and the labor market, employment is still expected to contract by some 1% this year and begin to increase only in the course of 2011. Unemployment rate is projected to stabilize at close to 10% - or half a percentage point lower than projected last autumn - in the EU, though the situation differs markedly across Member States.

The recession has had a major impact on public finances. As a result of the operation of automatic stabilizers and the discretionary measures taken to support the economy within the framework of the European Economic Recovery Plan, the government deficit has tripled since 2008. It is projected to peak this year in the EU (reaching 7¼% of GDP) and to improve slightly in 2011 (to around 6½%). This follows from the expiry of temporary support measures and the pick-up in activity. The debt ratio is set to remain on an increasing path. The on average high and increasing public debt is the longest lasting legacy of the crisis; it will impact the economy long beyond the current forecast horizon.

Inflation set to remain subdued

Consumer-price inflation has rebounded somewhat from the very low levels recorded last year. Nevertheless, the remaining slack in the economy is likely to keep both wage growth and inflation in check, partly offsetting an assumed increase in commodity prices and, for the euro area, a weaker euro. HICP inflation is forecast to average 1¾% in the EU both this year and next (and 1½% and 1¾%, respectively, in the euro area).

Uncertainty still high, risks broadly balanced

The EU recovery continues to be surrounded by high uncertainty, illustrated e.g. by the recent tensions in sovereign-bond markets. The forecast is also subject to uncertainty, with broadly‑balanced risks. As the economy is emerging from a recession accompanied by a financial crisis, the recovery crucially relies on the soundness of financial markets, which has yet to be solidly re-established. Also a renewed widening of global imbalances could impact on European growth prospects.

Notwithstanding apparent signs of stabilization, the labor market situation is projected to remain weak. Developments on this front will be of key importance to the recovery process in the EU and could be a potential source of both downside and upside risks, depending also on the effectiveness of policy measures. On the other hand, the rebound in emerging markets and the resulting recovery of trade could boost the EU economy further, beyond what is currently expected. The recent upsurge in confidence (especially in manufacturing) points to some upside risks in the near term. A successful completion of the financial support to Greece can be expected to increase investor and consumer confidence. Risks to the inflation outlook are also broadly balanced. (EC)