Euro Area Economic Forecast

GDP expanded quarter on quarter in Q1, albeit timidly. Higher interest rates, sticky inflation and global headwinds restrained activity. Conditions remain challenging in Q2 due to the lagged effects of previous interest rate hikes and still-elevated inflation. That said, in April, consumer sentiment rose—although it remained pessimistic—and the Composite PMI increased further as growth in the services sector more than offset a deepening downturn in manufacturing activity. In late April, the European Commission proposed reforming the Stability and Growth Pact to offer more flexibility to national governments in reducing their public debts, while increasing monitoring and enforcement of related plans. Meanwhile, the IMF recently urged EU governments to pursue more ambitious fiscal consolidation to rebuild budgetary space and support the ECB in fighting inflation.

Harmonized inflation declined again in March, coming in at 6.9% from February’s 8.5%, mainly due to a fall in energy prices. Inflation should ease ahead, limited by higher interest rates and subdued domestic demand. A wage-price spiral poses an upside risk, as does a less-hawkish-than-expected monetary policy stance should financial turbulence reignite.