Economic Forecast, spring 2009: the widespread economic downturn may trigger trade-distorting protectionist measures

The European Commission issued on 4 May 2009 its spring economic forecast. Beside its optimistic press release, the analysis show that the risk of a worse-than-expected outlook for economic activity relates, in particular, to the impact of the financial crisis and the strength of the negative feedback loop between different sectors of the economy. For instance, a sharper deterioration of the real economy may aggravate the housing-market correction in some countries and may also reinforce the banking deleveraging process, pushing the projected recovery further into the future. Some economies with substantial (external) financing needs also face the risk of sudden shifts in investors’ risk preferences and difficulties in securing the necessary financing as recently illustrated by developments in some Central and Eastern European economies. Moreover, it cannot be excluded that the widespread economic downturn may trigger trade-distorting protectionist measures.

Turning to inflation, risks partly relate to future commodity price trends, where weaker demand poses a downside risk, while the possibility of further supply restrictions points in the opposite direction. The disinflationary impact of a severe recession on wage and price setting may also prove more pronounced. However, the risk of a deflationary scenario at the EU or euro-area level, i.e. a persistent and self-reinforcing decline in a broad set of prices, appears limited at the current juncture. Inflation expectations remain anchored at levels consistent with price stability; wage growth is expected to remain positive, while both fiscal and monetary policies have turned expansionary.

World GDP is expected to contract by some 1.5% in 2009, with the downturn being especially pronounced in advanced economies. GDP is projected to fall by about 3% in the US and by a stark 5.25% in Japan in 2009. Moreover, the economic downturn has increasingly spilled over to emerging and developing economies. Although China seems to be in a relatively good position to counter the global recession in view of the arsenal of policy instruments still available, growth is expected to slow sharply this year (to some 6%).

Among the five largest EU economies, real GDP is expected to contract this year by about 5.5% in Germany, some 4-4½% in Italy and the United Kingdom and by about 3% in France and Spain. Activity is expected to broadly stabilise in all of the larger economies in 2010, except Spain where a further contraction of close to 1% is predicted. Moreover, population growth continues to play a positive role in the case of Spain, where GDP per capita growth, at -4.5%, is in line with the euro-area average this year and is expected at close to -2% in 2010.

Although the economic downswing has become more broad based in recent quarters, differences across EU countries persist. Strongly export-oriented economies have been particularly affected by the collapse in global manufacturing. Some countries remain subject to a deeper and more protracted downturn due to their direct exposure to the financial crisis or a substantial housing-market correction. Some countries also face deterioration in external financing conditions following the build-up of imbalances and vulnerabilities, which fuel financial markets’ concern.

The downturn is also expected to be widespread across demand components, with the exception of government consumption and public investment as these are supported by budgetary stimulus proposed in the European Economic Recovery Plan. Exports and investment are set to contract particularly sharply this year (by 12.75% and 10.5%, respectively).

You may find more details on economic forecasts for the EU Member States at:
http://ec.europa.eu/economy_finance/thematic_articles/article14927_en.htm

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