Following five consecutive quarters of vigorous GDP growth, economic momentum in the euro area moderated in the first half of the year. GDP growth eased to 0.4% (q-o-q) in the first quarter and the evidence available so far suggests that this softness extended into the second quarter. Outside the EU, activity remains solid overall but growth rates are becoming more differentiated across countries and regions and downside risks are rising. Although the slowdown of European economic activity in early 2018 is widely believed to have reflected a number of temporary factors, confidence and activity failed to rebound in spring, as trade tensions escalated, political uncertainty rose in some Member States, and oil prices continued their rising trend. While the nature of the current ‘soft patch’ is not yet fully clear and developments in global trade policy have emerged as a major downside risk to the near and medium term outlook, the fundamentals for sustained growth in Europe remain in place. The euro area economy continues to benefit from supportive monetary conditions, with low financing costs for companies and governments despite the expected gradual withdrawal of monetary stimulus. Furthermore, brightening labour market conditions, as well as improving household balance sheets and still elevated levels of consumer confidence, should ensure continued private consumption growth going forward despite some dampening effect from higher energy prices. Finally, while the support from the external environment is subject to great uncertainty in view of current trade policy tensions, the direct impact of protectionist measures so far remains limited and the baseline forecast continues to see an expansion in global trade this year and next, which should ensure continued demand for European goods and services. Overall, euro area and EU economies are set to continue expanding this year and in 2019, but at a more moderate pace than in 2017 when growth was the fastest in a decade. Mirroring the weaker-thanexpected activity in the first half of the year, the outlook for GDP growth in the euro area and the EU in 2018 has been revised to 2.1%, down by 0.2 pps. compared to the spring forecast, and remains unchanged at 2.0% in 2019. Wages and core inflation pressures are still expected to rise only gradually over this year and next. Headline inflation in the euro area has, however, been revised up to 1.7% in both 2018 and 2019 as a result of higher energy prices. This relatively benign outlook is, however, predicated on the non-escalation of trade tensions and conflicts at global level. Hence significant downside risks exist. First and foremost, if trade tensions with the US were to escalate further, this could dampen confidence more permanently, weighing on global investment and trade flows, and likely disrupting the current global cyclical upswing. This adds to concerns about the potential for negative consequences from renewed bouts of financial market volatility and a faster-than-expected tightening of global financing conditions, as well as increased imbalances stemming from the highly pro-cyclical fiscal policy in the US. Additional risks relate to political and policy uncertainty in a number of EU countries (including the outcome of Brexit negotiations), as well as political and geopolitical tensions outside Europe.
