Dark economic clouds leave Brussels jittery over recovery

Rising prices, debt and COVID-19 infection rates are starting to overshadow Europe’s economic recovery story.

The European Commission on Wednesday told governments to stay alert and be ready to act if the dark clouds on the horizon turn into a storm, as part of its efforts to coordinate economic policy across the bloc — known as the European Semester.

The calls for caution come despite Brussels’ strong growth forecasts, following the deepest recession since World War II. The eurozone’s economy is set to expand by 5 percent this year on the back of strong vaccination rates and continue that growth next year with a rise of 4.3 percent.

But those forecasts are subject to huge uncertainties that have emerged in recent months from rising energy prices and a “pandemic of the unvaccinated,” especially in Eastern Europe, triggering a cautious tone from the Commission.

“The European economy is growing strongly but being buffeted by headwinds: sharply increasing COVID cases, spiking inflation and ongoing supply-chain issues,” Economy Commissioner Paolo Gentiloni said in a statement. “This complex economic picture calls for carefully calibrated policies.”

“We need to both keep the recovery on track and shift towards a more sustainable, competitive and inclusive growth model for the post-pandemic era,” the Italian added.

Cautious language was particularly targeted at Belgium, France, Greece, Italy and Spain, which have seen their high levels of public debt increase over the pandemic. Italy in particular should try to contain its public spending and make full use of the EU's recovery fund, the Commission said. The others need to keep a close eye on their budgets.

The Autumn European Semester is built on draft spending plans for next year that governments sent to Brussels for scrutiny after the summer.

Normally, the Commission would check to see whether these drafts are in line with the bloc’s debt and deficit rules. But these rules have been on ice since March 2020 to ensure countries had enough fiscal firepower to battle the pandemic and rescue their economies. They’ll be reintroduced starting in 2023.

Until then, the Commission can merely advise governments on what spending policies to pursue in a general assessment of their budget drafts.

The advice is largely unchanged: Countries need to keep spending to keep the recovery on track and make full use of the EU’s €723.8 billion recovery fund. Governments do, however, need to start shifting public funds away from emergency measures and toward projects that will boost the economy with reforms and investments in green and digital infrastructure.

Imbalances widen

Additionally, the pandemic has worsened certain macroeconomic imbalances across the bloc, such as rising house prices and a high debt burden on companies, the Commission said.

Wages are also on a “substantial” climb in some countries, as demand for workers increases to match the economic rebound. That could also feed into rising prices.

High corporate debt could become a problem once governments start pulling back public support, leaving companies on their own to pay back their bills and loans.

That’ll impact the banking industry if such companies stop paying back their loans. These soured loans could drag on bank balance sheets, forcing them to hold back lending to the real economy.

The Commission will scrutinize these imbalances by carrying out in-depth reviews on Croatia, Cyprus, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, Romania, Spain and Sweden. These reviews will be published next spring.

Commission officials are still confident of their positive economic forecast in the face of growing uncertainties. The EU’s recovery fund, if used properly, and continued vaccination efforts will translate into high growth, which in turn helps treasuries and companies drive down their debt.

“Our coordinated economic policy response to the pandemic over the past two years has been both strong and successful,” Gentiloni told reporters. “Now we must navigate a new, altogether more complex phase.”

This story has been updated.