Euro zone economic growth will be slightly better than expected this year thanks to a robust third quarter, but financial market turbulence will slow it next year and in 2009, the European Commission said on Friday.
In a twice-yearly economic forecast, the Commission raised its projection for growth in the 13 countries using the euro this year to 2.6 percent from 2.5 percent seen in September and against 2.8 percent growth in 2006.
Next year, euro zone growth is seen slowing to 2.2 percent and then further to 2.1 percent in 2009.
"This follows from the impact of the turbulence in the financial markets that has caused tighter financing conditions and increased uncertainty," the Commission said.
The main growth engines will be domestic demand and private consumption in particular, thanks to falling unemployment, which the Commission sees at 7.1 percent next year against 7.3 percent this year as 3.2 million new jobs are created.
It said labor shortages were becoming more common and wage growth was therefore likely to pick up in 2008 in particular, reflecting catching-up on previous years of wage restraint.
"But sustained labor productivity growth is set to limit the rise in unit labor costs and help contain inflation pressures," it said.
The Commission said that euro zone inflation, which the European Central Bank wants to keep just below 2 percent, would be 2.0 percent this year, inch up to 2.1 percent in 2008 and fall back to 2.0 percent in 2009.
It said, however, consumer prices were likely to grow as fast as 2.4 percent in the fourth quarter of this year and fall back towards 2 percent only in the third quarter of 2008.
The ECB also expects an inflation "hump" over the coming months due to a surge in food and oil prices and, even though the bank's tone remains hawkish, economists expect it will keep rates on hold well into 2008.
"The balance of risks for economic growth is now clearly tilted to the downside and to the upside for consumer price inflation," the Commission said.
The biggest downside risks were the global credit crunch and a sharper or longer economic slowdown in the United States.
Based on future prices, the Commission said it assumed Brent crude oil would cost $70.60 per barrel on average this year, $78.80 in 2008 and $76.00 in 2009.
Based on averages from Oct. 5-18 the Commission assumed the euro would buy on average $1.36 in 2007, and $1.42 in 2008 and 2009.
For ECB interest rates, the Commission assumed short- and long-term rates would be 4.3 percent on average in 2007 and 4.4 percent in 2008. In 2009, it assumed short-term interest rates at 4.3 percent and long-term rates at 4.5 percent.