(1)

The euro area’s economic recovery in the period following the COVID-19 pandemic has been interrupted by a series of external shocks. Thanks, in particular, to a decisive economic policy response, both at national and Union level, and to the lifting of containment measures, the euro area posted solid GDP growth in 2021 and 2022, namely 5,3 % and 3,5 % respectively. The labour market also proved resilient, with unemployment reaching a record low rate of 6,7 % in 2022. However, the increase in global energy prices, heightened uncertainty and supply chain disruptions induced by Russia’s war of aggression against Ukraine resulted in a clear deceleration in economic activity in the second half of 2022. The energy crisis has led to a downward reassessment of forecasts for 2023. Overall, GDP growth in the euro area is set to decrease to only 0,3 % in 2023 before returning to 1,5 % in 2024. The energy market and other commodities markets have been fuelling inflation, which over time has broadened into other items and reached 8,4 % in 2022. Inflation is now expected to remain elevated in the coming months, staying at 6,1 % in 2023 before easing in 2024. Labour markets are expected to remain robust as demand for labour remains high. With a large share of businesses still reporting labour shortages, unemployment is set to increase only moderately next year, before abating again in 2024. Meanwhile, nominal wage growth is expected to increase in 2023, but to remain below inflation, leading to a drop in purchasing power of households.

In this context, the euro area’s current account surplus has receded, in line with the strongly deteriorating energy balance and, going forward, the nominal depreciation of the euro against the US dollar and some other currencies since the second half of 2021 is likely to provide only a modest boost to competitiveness given the high energy costs.

(2)

The deterioration in macroeconomic conditions and large price differentials across Member States challenge income and business cycle convergence in the euro area. While the COVID-19 pandemic led to deep, though largely transitory, divergences in macroeconomic performance, it had a limited and temporary impact on business cycle synchronisation. The energy crisis brings with it new heterogeneous macroeconomic impacts in the euro area. Due to cross-country differences in energy mixes and in policies to mitigate the impact of the energy shock, large differences in headline and core inflation rates have emerged across the euro area. Higher energy prices and supply chain pressures have had an uneven impact on manufacturing and services across euro area Member States and could result in drifting relative competitiveness. While available indicators suggest that competitiveness gaps within the euro area have been limited so far, divergences in current account balances in the euro area have recently widened, mainly on the back of deteriorating energy balances.

(3)

Ensuring an appropriate and coordinated policy response to a deteriorating economic outlook and high inflation require monetary and fiscal policies to be appropriately calibrated and coherent. Monetary policy has to address high inflation. The European Central Bank (ECB) stands ready to tackle possible risks of unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area. In the current climate, a broad-based fiscal expansion to support demand would further fuel inflationary pressure. Public debt is elevated in several euro area Member States. This calls for fiscal policies that are appropriately differentiated across Member States according to their economic and fiscal situation, as recommended by the Council in its recommendations of 12 July 2022 on the National Reform Programmes and delivering Council opinions on the 2022 Stability Programmes of each Member State (3). It also requires them to be prepared to adjust nationally-financed current primary spending to the evolving situation while preserving debt sustainability. At the same time, targeted and temporary fiscal measures are needed to support vulnerable people and companies, also with a view to maintaining jobs and human capital, while preserving price signals and providing incentives to reduce energy consumption. Close coordination of policy responses between Member States remains crucial. Labour market and social policies are also instrumental in addressing the social impacts of high inflation. Average wages did not keep up with inflation in 2022.

Going forward, wage developments need careful balancing to protect wage earners’ purchasing power – with a focus on low-wage earners – while avoiding the risk that wages feed inflation and deepen emerging competitiveness differentials within the euro area and worldwide. Promoting quality employment could also help to sustain consumption. Active involvement of social partners helps identify challenges, including as regards the specific challenges for the monetary union, improves policy solutions and ensures broader ownership of the economic and social policy agenda. Supply-side policies can also contribute to lower inflation by accelerating the build-up of alternative energy supplies, enhancing competition and innovation, improving the allocation of resources, and supporting productivity growth. Risks to financial stability also require continued monitoring.

(4)

The Recovery and Resilience Facility established by Regulation (EU) 2021/241 of the European Parliament and of the Council (4) (the ‘Facility’) and cohesion policy funds are key tools for strengthening the resilience of the euro area and support convergence. The implementation of the Facility in the euro area Member States is well on track, with over EUR 136 000 000 000 paid in pre-financing and following the fulfilment of milestones and targets. Since the outbreak of the COVID-19 pandemic, cohesion policy programmes disbursed over EUR 82 000 000 000 to euro area Member States. The Facility and cohesion policy funds contribute to the euro area policy priorities through several channels: both support economic activity through additional investment and, in the longer term, the planned investments and structural reforms are set to support the green and digital transition while stimulating higher growth in productivity and potential output, as well as enhancing the resilience of Member States. A large proportion of investments and reforms carried out as part of the Facility is relevant for the implementation of euro area policy priorities identified in previous euro area recommendations. Accordingly, continuing to implement agreed reforms and investments based on the planned schedule is essential to maintain the reform momentum.

(5)

The Annual Sustainable Growth Survey contained in the communication of the Commission of 22 November 2022 outlines the key policy priorities and guidelines for the year ahead to ensure a consistent economic policy response at the Union level. The Annual Sustainable Growth Survey is structured around the four dimensions of competitive sustainability: environmental sustainability, fairness, productivity, macroeconomic stability and is in line with the United Nations Sustainable Development Goals. Additionally, the Alert Mechanism Report 2023 published on 22 November 2022 provides the Commission’s analysis of potential macroeconomic imbalances that may hinder the proper functioning of Member State economies, the Economic and Monetary Union and the Union as a whole.

(6)

The rapid increase in inflation over the past year has prompted a rapid adjustment of the monetary policy stance worldwide. The ECB has started normalising monetary policy to ensure a timely return of inflation to the 2 % medium-term target. It has also indicated that the normalisation of interest rates will continue, taking into account economic data developments. Supply constraints play a significant part in the recent inflation surge, and inflation differentials make the conduct of monetary policy more challenging. An even transmission of the policy stance across the euro area is a precondition for monetary policy to deliver on its mandate.

(7)

The euro area fiscal stance, measured as the change in net primary expenditures relative to average potential growth, was projected to be expansionary in 2022 and broadly neutral in 2023, according to the Commission, but would turn expansionary if additional energy support measures were to be enacted or current ones prolonged throughout 2023. In 2023, fiscal policy should avoid amplifying the inflationary effects of the ongoing supply shocks and, both at national level and for the euro area as a whole, a broad-based fiscal impulse to the economy is not warranted. The challenge is particularly acute for Member States experiencing high core inflation, also in light of the serious economic and social difficulties inflicted by the erosion of wage earners’ purchasing power, in particular for low wage earners. Moreover, fiscal policy should remain prudent and combine higher investment with controlling the growth in net primary current expenditure. In this context, the expected further increase in the Facility absorption and in nationally-financed investments across Member States is consistent with the need to expand public and private investment for the green and digital transition and for energy security. At the same time, the fiscal policy agility would help to respond to high uncertainty and strong downside risks to the economic outlook, while not undermining incentives for the energy transition. The COVID-19 pandemic has left a legacy of very high debt in the euro area, and while public debt is expected to decline, it will remain well above the pre-pandemic levels. While short-term sustainability risks have largely decreased, medium- and longer-term risks remain elevated in several Member States, and interest rates rises are expected to gradually feed into a higher debt burden.

(8)

In order to respond to the increase in energy prices, euro area Member States have taken emergency measures estimated to represent 1,25 % of GDP in 2022 and up to 1 % in 2023, with the expected decrease contingent on developments in the price of energy and on the planned roll-back of the related measures. Based on the Commission’s services autumn 2022 economic forecast, the measures taken so far mainly aim at mitigating price increases, and on average only 20 % are targeted income measures. There is a need to limit the fiscal cost of such support measures, while taking into account their distributional impact across income brackets, the impact on energy demand and investment in the green transition, possible distortions to the single market and negative spillovers across Member States. To that end, it is important to agree on a common approach. In particular, a well calibrated two-tier energy pricing model, whereby vulnerable consumers benefit from regulated prices up to a certain level of consumption, and other schemes that achieve similar objectives, taking into account national features, could be explored. Additionally, there could be reflection as regards appropriate ways to wind down support as energy price pressures diminish. Besides temporary energy measures, public and private investment can help bolster energy independence and security and the green transition. Since the global financial crisis, the euro area has been suffering from low levels of both private and public investment.

Policy steps taken in response to the COVID-19 crisis, with the exceptional support of NextGenerationEU, have helped maintain the level of public investment, with a positive impact on potential growth, especially in the Member States with the highest public debt burden. Further private and public investment, in particular through the implementation of the recovery and resilience plans, of cohesion policy programmes, and of national energy and climate plans to be updated by Member States by June 2023, is critical for sustainable and cohesive growth and to achieve the green and digital transition.

(9)

On 9 November 2022 the Commission published a communication on orientations for a reform of the EU economic governance framework to improve the effectiveness of economic surveillance and policy coordination in the Union. That communication aims to define a simpler and integrated architecture for macro-fiscal surveillance to ensure debt sustainability and promote sustainable and inclusive growth. The key elements of that communication aim at simplifying the framework, improving national ownership and strengthening enforcement. That communication proposes that fiscal trajectories are set out in medium-term fiscal-structural plans proposed by Member States, within a transparent common Union framework. Those plans, which would be adopted by the Council, would bring together fiscal, reform and investment commitments supporting debt sustainability and sustainable growth and reflecting Union and national priorities. Reform and investment commitments in the national medium-term fiscal-structural plan would allow for a longer fiscal adjustment period.

While maintaining the Treaty reference values of 3 % of GDP for the deficit and 60 % of GDP for the debt, the framework would rely on a more risk-based surveillance focused on debt sustainability. As regards the macroeconomic imbalance procedure, it is important to continue to address macroeconomic imbalances in a coordinated and balanced manner. The Commission communication proposes a more forward-looking framework to be able to identify emerging risks as they develop. The assessment of whether imbalances exist would remain based on the three criteria of gravity, evolution and the policy response. However, the criteria of evolution and the policy response by the Member State concerned would be given more weight in the assessment.

(10)

The euro area labour market has shown remarkable resilience thanks to policy support during the COVID-19 crisis. In the first quarter of 2022, total hours worked surpassed pre-pandemic levels, and employment continued to grow throughout the first half of 2022 to historically high levels in the second quarter of 2022 pushing the unemployment rate to 6,8 %, its lowest level since the creation of the euro. Still, scope for improvement remains with regard to the labour market integration of women, young and older people, persons with disabilities and vulnerable groups. Going forward, the expected slowdown in economic activity is set to weigh on employment prospects, with unemployment rate slightly increasing in 2023. There is little evidence that the COVID-19 crisis led to a structural deterioration in job matching.

However, there are significant labour market differences across Member States and sectors. Since 2019, job creation has been the strongest in information technology and professional services while transportation, accommodation and food have recorded job losses. Demographic change is likely to also play a role in the tightening of euro area labour markets. Adequate and effective investment in quality education and training at all ages will be key to mitigating current and future skills shortages and supporting the green and digital transition. Wage growth somewhat increased during 2022, leading to an aggregate increase in unit labour costs. However, it remained moderate overall and is projected to stay well below inflation. Real compensation by employee is projected to contract by 2,8 % in 2022 and by a further 0,9 % in 2023 before recouping part of the loss in 2024. Anchored inflation expectations play a key role in mitigating risks that rapid rises in wage claims push inflation further up.

(11)

Structural reforms, including those carried out as part the European Green Deal or green and digital reforms supported by the ‘Facility’, in particular following the amendments introduced in Regulation (EU) 2021/241 by Regulation (EU) 2023/435 of the European Parliament and of the Council (5) in order to implement the REPowerEU Plan contained in the communication of the Commission of 18 May 2022, are key to strengthen the single market and the resilience of the euro area economies. In that regard, it is also important to implement the country specific reforms recommended by the Council in 2022 in the context of the European Semester. Further improving the business environment, including by reducing barriers to investment and to the reallocation of capital, modernising public administrations, speeding up the granting of permits while protecting the environment, and removing restrictive regulatory frameworks can increase productivity and growth. Reforms, together with investment, are instrumental to accomplishing the green and digital transition, in particular for improving energy efficiency, supporting the transition towards climate neutrality, increasing the supply and deployment of renewable energy, as well as supporting reskilling and upskilling. The rapid and persistent rise in energy prices has put the business models of energy-intensive industries and small and medium enterprises under pressure, with an impact on jobs and human capital. Efficient insolvency regimes can support the transition and make it easier to reallocate resources. Insolvency regimes across the euro area still differ greatly and increasing their effectiveness and harmonisation would support economic adjustment and the single market for capital.

(12)

The banking sector showed overall resilience in 2022. While the euro area banking sector as a whole is well capitalised and has seen an improvement in profitability since 2021, a sharp deterioration in the macroeconomic outlook, together with higher interest rates raising costs for borrowers, may translate into weaker asset quality. In a context of tighter access to credit, timely monitoring of risks, proactive engagement with debtors and active management of non-performing loans is important to maintain banks’ ability to finance the economy. The resilience of credit institutions can be hampered by structural factors, including overcapacity and competition from new financial service providers. Other risks can also emerge on the financial markets. In particular, higher risk premiums and tightening liquidity conditions can lead to a fall in asset prices. Due to margin calls, this can cause further pressures beyond the liquidity stress already experienced by some energy companies. How the residential and commercial real estate markets react to higher interest rates also requires close monitoring, as lower demand and worsening debt-servicing capacity can exert downward pressure on real estate prices and accentuate cyclical risks, in particular in euro area Member States where household debt is elevated. Moreover, increased cyber risks call for greater attention, and Regulation (EU) 2022/2554 of the European Parliament and of the Council (6) will strengthen financial firms’ resilience against risks related to information and communication technologies. In September 2022, the European Systemic Risk Board issued Recommendation ESRB/2022/7 containing a warning asking private sector institutions, market participants and relevant authorities to continue to prepare for tail-risk scenarios.

(13)

In June 2022, the Eurogroup agreed that, as an immediate step, work on the future of the Banking Union should focus on strengthening the common framework for bank crisis management and national deposit guarantee schemes to have a framework that is suited to all types of banks. The Eurogroup committed to subsequently review the state of the Banking Union and identify, in a consensual manner, possible further measures regarding the other outstanding elements to strengthen and complete the Banking Union. The Commission has announced that it intends to make a legislative proposal on the crisis management and deposit insurance framework in the first half of 2023. Modifications to the crisis management and deposit insurance framework can help make the euro area banking sector more resilient. The Commission has also announced that in the first half of 2023 it will table a legislative proposal that would establish the digital euro and regulate its main features, subject to the decision of the co-legislators. A possible decision regarding the issuance of the digital euro would be taken by the ECB Governing Council after the completion of a potential realisation phase. A digital euro, which would be complementary to cash, could bring with it several benefits for the euro area economy. It would, in particular, support the digitalisation of the economy and innovation in payments, while also strengthening the international role of the euro. Developing a digital euro could, also against the background of the current geopolitical situation, increase the economic and financial autonomy of the euro area and the Union,

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Further steps in deepening the Economic and Monetary Union should take into account the lessons learnt from the design and implementation of the Union’s comprehensive economic policy response to the COVID-19 crisis. Swift progress on the economic governance review is a priority for enhancing economic policy coordination. Progress in deepening the Economic and Monetary Union should be continued in full respect of the Union’s internal market and in an open and transparent manner towards non-euro area Member States.