In the Commission's spring forecast, GDP in the European Union is projected to fall by 4% this year and to broadly stabilise in 2010. The main factors behind the recession are the worsening of the global financial crisis, a sharp contraction in world trade and ongoing housing market corrections in some economies. However, with the impact of fiscal and monetary stimulus measures kicking in, growth is expected to regain some momentum in the course of 2010. Labour markets will be severely affected, with the unemployment rate expected to increase to 11% in the EU in 2010. The public deficit is also projected to rise sharply, to 7¼% of GDP in 2010, reflecting both the slowdown and the discretionary measures taken to support the economy, in line with the European Recovery Plan proposed by the Commission.

The worsening of the financial crisis led to a contraction of global activity and a sharp drop in world trade and industrial production during the winter. The economic downturn has swept a growing number of countries along in its wake, including emerging and developing countries. However, as fiscal and monetary stimulus measures gain traction and the financial crisis gradually peters out, global GDP growth is forecast to turn positive again in the second half of 2009. In 2010, global growth is expected to reach 2%.

Sharp recession in the EU but with an end in sight

The recession that started in the second quarter of 2008 worsened towards the end of the year, with both the EU's and the euro area's GDP declining by about 1½% (quarter-on-quarter) in the last quarter. Survey and hard data suggest a further deterioration in the first quarter of this year. All Member States are affected by the downturn, although their prospects vary depending on their relative exposure to the financial crisis, housing-market dynamics and degree of openness.

As financial markets stabilise, investor confidence improves and both fiscal support and monetary easing gradually feeds through to real activity, the fall in GDP is set to level off towards the end of this year and growth rates should turn modestly positive during 2010.

The downswing is affecting not only all Member States but also almost all demand components. Private investment is particularly hit, reflecting depressed demand expectations, a sharp fall in capacity utilisation and still tight financing conditions. Similarly, exports have contracted sharply in light of the marked drop in world trade. While private consumption is still holding up relatively well, helped by lower oil prices and lower inflation, real disposable income is likely to be dampened by a progressive deterioration in the labour market. Only government consumption and public investment will contribute positively to growth this year, thanks partly to the budgetary stimulus measures taken under the EU Recovery Plan.

Labour market and public finances hit hard

European labour markets began cooling in the course of last year, with their usual time lag behind the economic slowdown. Looking ahead, employment is expected to contract by about 2½% in both the EU and the euro area this year and by a further 1½% in 2010, resulting in about 8½ million job losses for the two years, in contrast to the net job creation of 9½ million during 2006-08.

Public finances are also being hit hard by the recession, with the budget deficit set to more than double this year in the EU (from 2.3% of GDP in 2008 to 6%) and to increase further in 2010 (to 7¼%). The sharp deterioration in the overall fiscal position is in part due to the economic slowdown itself, as automatic stabilisers are relatively large in Europe, but it also reflects the sizeable discretionary budgetary stimulus to support economic activity.

Inflation very low, temporarily

Inflation has fallen sharply in recent months and is projected to continue to do so during the second and third quarter of this year, due to further base effects, a weak economic outlook and an assumed decline in commodity prices. Overall, HICP inflation is projected to be slightly lower than 1% in the EU (and ½% in the euro area) in 2009, and to reach a trough in the third quarter in both regions. As base effects of past hikes in energy and food prices drop out of the annual rate this autumn, HICP inflation is expected to gradually pick up to about 1¼% next year.

Considerable uncertainties remain

The Commission's report underlines that, with the global economy facing its worst recession since the World War II, the economic and inflation outlook is subject to considerable uncertainty. The risk of a worse-than-expected outlook hinges in particular on the impact of the financial crisis and the strength of the feedback loops between different sectors of the economy. On the other hand, fiscal and monetary stimulus measures might be more effective than anticipated in restoring stability and confidence in financial markets and supporting economic activity. Risks to the inflation outlook appear balanced this year, stemming from possible developments in commodity prices as well as price- and wage-setting behaviour.