Domestic price pressures remain elevated, primarily owing to strong growth in unit labor costs
The past interest rate increases continue to be transmitted forcefully to the economy.
Tighter financing conditions are dampening demand, and this is helping to push down inflation.
The euro area economy contracted slightly in the third quarter of 2023, mostly owing to a decline in inventories.
Tighter financing conditions and subdued foreign demand are likely to continue weighing on economic activity in the near term.
Prospects are especially weak for construction and manufacturing, the two sectors most affected by higher interest rates. Services activity is also set to soften in the coming months.
The labor market continues to support the economy.
Growth is expected to strengthen from early 2024 onwards, as real disposable income rises and export growth catches up with improvements in foreign demand.
Overall, annual average real GDP growth is expected to slow down from 3.4% in 2022 to 0.6% in 2023, before recovering to 0.8% in 2024 and stabilizing at 1.5% in 2025 and 2026.
As the energy crisis fades, governments should continue to roll back the related support measures. This is essential to avoid driving up medium-term inflationary pressures, which would otherwise call for even tighter monetary policy.
Fiscal policies should be designed to make the euro area economy more productive and to gradually bring down high public debt.
The risks to economic growth remain tilted to the downside.
Growth could be lower if the effects of monetary policy turn out stronger than expected.
A weaker world economy or a further slowdown in global trade would also weigh on euro area growth.
Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East are key sources of geopolitical risk.
Upside risks to inflation include the heightened geopolitical tensions, which could raise energy prices in the near term, and extreme weather events, which could drive up food prices.
Inflation could also turn out higher than anticipated if inflation expectations were to move above the Governing Council’s target, or if wages or profit margins increased by more than expected.
Inflation may surprise on the downside if monetary policy dampens demand by more than expected or the economic environment in the rest of the world worsens unexpectedly, potentially owing in part to the recent rise in geopolitical risks.