Our 2023 outlook for the euro area economy

The euro area economy has been surprisingly resilient since the start of the war in Ukraine in February. This can be partially attributed to the post-pandemic rebound in some service industries, as well as government measures to shield consumers and companies from high energy costs. The good health of the labour market has also been a key support. Latest data are pointing to a mild recession in the euro area in the early part of next year. We expect euro area GDP to contract by 0.2% in 2023, down from growth of 3.3% in 2022. 

NextGenerationEU, the EU’s recovery fund, will continue to support growth, particularly in peripheral countries. The continued resilience of the labour market and the pick-up in wages will also be a key support for household consumption and help mitigate the negative effect of the energy shock. In addition, the easing of supply-chain constraints should help European manufacturers regain some momentum.

We expect headline inflation to fall moderately in 2023, driven by energy. While the easing of supply bottlenecks should also help to slow inflation, rising wages, the indirect effects of the energy shock as well as the carryover from strong consumer demand this year should ensure price pressures remain elevated. We see headline inflation in the euro area averaging 5.3% in 2023, down from 8.5% in 2022. 

We have adjusted our rates expectations to take account of the hawkish message delivered by the European Central Bank (ECB) at its December meeting. We now see the ECB hiking its policy rate by 50bp in each of February, March and May next year, before it marks a pause. This will bring the deposit rate up to 3.5% by the end of May 2023. 

We think it will be difficult for the ECB to go further given the lagged impact of monetary tightening, particularly on countries with high debt, the negative impact on households’ income and the likelihood that the US Federal Reserve will have paused its own rate hikes by then. Nonetheless, we think persistently high core inflation will preclude any rate cuts from the ECB until H2 2024. As part of its plans for quantitative easing, we expect the ECB to step back entirely from reinvest proceeds from its asset purchase programme in Q3 2023.