Revised growth forecasts point to slower Eurozone fiscal recovery
Weaker eurozone GDP growth prospects will slow, but not reverse, the bloc’s post-pandemic fiscal recovery under Fitch’s latest forecasts, Fitch Ratings says.
We still forecast narrower deficits in nearly all eurozone member states in 2022, partly due to last year’s outperformance, but we expect their updated Stability Programmes to show slower fiscal consolidation strategies in response to the Ukraine conflict.
We cut our 2022 eurozone growth forecast by 1.5pp to 3.0% in our latest Global Economic Outlook to reflect the high exposure to the energy shock and the sharp rise in eurozone wholesale gas prices, which will have a large impact on headline inflation and real incomes. Of the largest economies, Germany and Italy have a particularly high exposure to Russian energy; we cut their growth forecasts by 1.9pp and 1.6pp, respectively.
We have raised our inflation forecasts sharply. With energy prices rising more than 30% annually in February 2022, adding pressure to input costs, and food prices also climbing, we now forecast eurozone inflation to average 5.0% this year, from 2.6% in December 2021. Pan-European efforts to reduce reliance on Russian natural gas – which accounts for about 11% of eurozone primary energy consumption – could keep energy prices high.
European authorities are responding to the inflationary shock with fiscal measures initially focussed on protecting low-income households from higher energy prices. If the crisis persists, we would expect wider-ranging measures including tax cuts.
The Ukraine-Russia conflict will also have budgetary costs via the refugee crisis and defence spending. The German government announced a sharp increase in the defence budget including a EUR100 billion fund to meet NATO’s 2%-of-GDP spending target. Italy plans to meet the target more gradually, by 2028.
These additional pressures are set to slow the eurozone fiscal recovery. However, outperformance in 2021, driven by revenue growth, provides some buffer to accommodate higher spending this year without significant revisions to fiscal targets. As a result, our latest 2022 deficit forecasts in March’s Sovereign Data Comparator have not changed much from December 2021’s.
Countries that have published general government deficit outturns for 2021 (including the four largest eurozone economies) significantly overperformed their original targets.
We estimate the eurozone’s aggregate general government deficit declined to 5.8% of GDP in 2021 from 7.3% in 2020, compared with our December estimate of 6.7%. We expect a further decline to 4.2% in 2022. The full fiscal impact of the conflict will partly depend on its length and continued effect on energy prices and supply.
The fiscal and monetary policy mix is different from the pandemic as the ECB appears determined to start normalising monetary policy. We expect this to constrain fiscal largesse, particularly in high-debt countries. For example, it may be reflected in recent decisions by Italy and Spain to impose windfall taxes on energy companies to fund part of their anti-inflation measures.
In our view, this may be a sign that high-debt countries are aware that their fiscal space for counter-cyclical policies is more constrained than it was at the start of the pandemic. Their 2022 Stability Programmes will be important to better assess the medium-term fiscal strategies being adopted in response to the Ukraine conflict.
The full fiscal impact would also depend on how far additional costs might be shared at the European level. We think the policy response to another common shock with asymmetric impacts will entail some burden-sharing, but new schemes are contentious, and in the short term, it is more likely that the European Commission will allow greater flexibility in fiscal rules due to return into effect in 2023.