Credit: European Commission

In its "Autumn 2023 Economic Forecast", the European Commission has revised Luxembourg's GDP growth for 2024 to 1.4%.

Real GDP growth is projected to fall by 0.6% in 2023, before recovering to 1.4% in 2024 and 2.0% in 2025. The below-average growth in 2023 is mainly due to weak investment linked to tighter financing conditions and to lower net exports, while their rebound explains the improvement in 2024, the European Commission noted. Following a peak in 2022, headline inflation is projected to slow down in the forecast period, aided by measures aimed at alleviating the effects of elevated energy prices. Anticipated government deficits are expected to contribute to an increase in the government debt-to-GDP ratio.

Anticipated to persist below pre-pandemic levels until 2025, real GDP experienced a minor upswing in 2023-Q1, only to contract by 0.1% q-o-q in 2023-Q2 on the back of decreased investment and exports. This downturn was attributed to reduced investment and exports, particularly impacting the financial, trade and construction sectors. Despite the contraction, domestic demand found support in growing private and government consumption, buoyed by additional government support measures and three wage indexations in 2023. However, the projected decline in private consumption growth, influenced by a slowing labour market and resulting precautionary savings, is expected to keep savings rates well above historical levels.

Furthermore, the uncertain economic outlook, compounded by higher interest rates affecting bank lending and loan demand, particularly for mortgages, is poised to keep investment weak. The negative contribution from net exports, driven by negative export growth, is anticipated to yield a GDP growth of -0.6% in 2023, significantly below pre-pandemic trends. Subsequent recovery in 2024 and 2025, with expected GDP growth rates of 1.4% and 2.0% respectively, is foreseen, primarily propelled by domestic demand, supported by private consumption and investment while government consumption levels off, accompanied by a more neutral contribution from net exports.

Concomitant with the economic slowdown, the labour market is projected to weaken, with employment growth decelerating from 3.4% in 2022 to 1.7% in 2023 and 1.2% in 2024. A gradual recovery is anticipated to commence in 2025 at 1.5%. Unemployment, having dropped to 4.6% in 2022, is projected to increase to 5.5% in 2023, 5.9% in 2024, and stabilise at 6.0% in 2025.

Addressing headline inflation, which soared to a record 8.2% in 2022, measures are in place to lower it. Expected moderation in energy prices, supported by energy measures (Solidaritéitspak 3.0), is forecasted to bring HICP inflation down to 3.2% in 2023, 3.0% in 2024, and further to 1.8% in 2025. Although strong wage growth is projected for 2023, the introduction of free public services is anticipated to dampen the increase in services prices. Headline inflation, excluding energy and food prices, is forecasted to decline from 4.2% in 2022 to 3.9% in 2023, with a continuation of this trend in 2024 (2.7%) and 2025 (2.3%).

The economic slowdown, coupled with the cost of fiscal support measures, is poised to impact public finances. In 2023, the government deficit is expected to widen to 1.9% of GDP, up from 0.3% in 2022. Contributing factors include weak economic growth, measures to counter high energy prices, and support for household purchasing power and corporate income. The deficit is projected to increase further in 2024 to 2.1% of GDP, with lower revenue growth attributed to the economic slowdown and revenue measures supporting households and corporations. Government deficits are predicted to drive the debt-to-GDP ratio upward, from 24.7% in 2022 to 29.3% in 2025.