As the EU charts its course through turbulent economic waters, the latest Winter Interim Forecast prepared by the European Commission this February paints a dull picture of the road ahead. Growth projections have been slashed, and inflationary pressures linger, threatening to derail hopes of a swift recovery. Lastly, insolvencies are at the pre-pandemic levels, signaling elevated credit risks for corporates ahead.

Poor Growth Prospects

Growth forecasts for both the EU and the euro area have been downgraded, signaling a grim reality of sluggish economic performance in the near term. Economic activity in 2023 staggered to a mere 0.5% expansion, with projections for 2024 offering little solace at 0.9% for the EU and 0.8% for the euro area according to the European Commission. Such tepid growth rates underscore the challenges plaguing the EU economy, with stagnation threatening to become the new norm. Doubts loom over the strength of the post-2024 rebound due to persistently low productivity according to Standard and Poor (S&P). The delay in implementing the Next Generation EU recovery plan adds to the woes, with projects representing a substantial gap in public spending that could stimulate the economy. Moreover, the implementation of the Next Generation EU recovery plan, aimed at fostering the green and digital transition, is falling behind schedule. Projects not completed by the third quarter of 2023 represent a gap of €127 billion, equivalent to 0.7% of 2023 EU GDP, which has yet to be spent to boost the economy. This delay contributes to the downward revision of growth expectations for 2025 and 2026, as S&P forecasts eurozone GDP growth to be 1.3% in both years, lower than previously expected.

Looming Inflationary Pressures

Inflation, once thought to be transitory, now poses a persistent threat to economic stability. Despite initial hopes of a downward trajectory, EU inflation remains stubbornly high, with forecasts predicting a gradual decline from 6.3% in 2023 to 3.0% in 2024. Rising prices erode purchasing power, dampen consumer sentiment, and undermine confidence in the economic outlook. Furthermore, risks of rising inflation loom on the horizon. Although wage growth is expected to remain high in the near term, coupled with developments in international trade, it could push inflation upwards, affecting the ECB’s rate-cutting decisions. Should the ECB cut interest rates as speculated by the financial markets (first cut is expected in June 2024), inflation could swiftly pick up momentum once again.

Elevated Corporate Insolvency Risks

The relatively healthy balance sheet positions and strong policy support that helped corporations weather the pandemic and energy shocks are now being tested. Skyrocketing energy prices, rising labor costs, and surging interest rates have weighed on firms’ profitability, leading to a broad-based increase in business bankruptcies. Despite policy interventions, bankruptcies surged above pre-pandemic levels, with concerns remaining about defaults, especially among lower credit quality segments.

S&P predicts that higher financing costs will become an increasing burden as 2025 and 2026 maturities are addressed. So, for lower-rated nonfinancial corporates, generating cash flow, protecting liquidity, and managing debt levels will be important to underpin debt sustainability and credit quality. Vulnerable segments include commercial real estate where there is a potential €93 billion funding gap between 2023-2026; and lower-rated corporate sectors, particularly consumer products, media and entertainment, chemicals, and capital goods sectors that comprise about 50% of entities rated in the ‘CCC/CC’ categories. S&P expects a gradual deterioration in credit quality, reflected in the default rate ticking up to 3.75% by September 2024 from 2.9% currently.

Conclusion

In conclusion, the economic outlook for the European Union appears clouded by uncertainty and challenges. With growth prospects dimming, inflationary pressures persisting, and corporate insolvency risks escalating, the road to recovery seems fraught with obstacles. The delayed implementation of crucial recovery plans adds to the concerns, exacerbating doubts about the strength of the post-pandemic rebound. As the EU navigates these turbulent economic waters, proactive measures and concerted efforts will be essential to mitigate risks and steer towards sustainable growth and stability.

This article was written by the team at ALPHA CREDO

Sources:

-The European Commission (2024). Winter 2024 Economic Forecast: A delayed rebound in growth amid faster easing of inflation. Retrieved on 03.04.2024 from here.

-Standard and Poor (S&P) (2024). Global Credit Outlook 2024: New Risks, New Playbook. Retrieved on 03.04.2024 from here.