What to Make of the Eurozone’s Slowing Growth

Following US Q1 GDP’s surprising contraction last Thursday, Eurostat reported slower-but-positive eurozone Q1 GDP growth of 0.2% q/q on Friday—with output mixed across the four largest economies.^[i] The report isn’t all sunshine and roses by any stretch. Yet rather than cheer the currency bloc’s resilience, headlines warned the slowdown could portend recession driven by the Russia-Ukraine war and high prices. Though eurozone Q1 GDP numbers don’t tell us much new on the economic front—and we aren’t dismissing the possibility of a regional recession—the reaction to them reveals how universally dour sentiment is in Europe today.

Of the 19 eurozone members, 7 reported Q1 GDP on Friday.^[ii] Portugal (2.6% q/q) and Austria (2.5%) led the way, but most headlines focused on the four largest economies.^[iii] While Germany (0.2%) and Spain (0.3%) grew, France flatlined (0.0%) and Italy contracted (-0.2%).^[iv]

Exhibit 1: Change in Quarterly GDP for Eurozone Nations, Q2 2021 – Q1 2022

Source: Eurostat, as of 4/29/2022. Quarter-over-quarter real GDP growth rate, Q2 2021 – Q1 2022.

The consensus estimate for Q1 eurozone growth was 0.3% q/q after last quarter’s 0.3% reading, so some argued the weaker-than-anticipated result signaled growing pressures from the war in Ukraine and soaring energy prices.^[v] A separate Eurostat report released Friday showed the harmonized index of consumer prices (HICP) rose a record-high 7.5% y/y in April—with energy prices up 38.0%—prompting some to conclude the economic situation may get even worse since energy tensions with Russia are building.^[vi]

While Eurostat’s initial estimate doesn’t provide much detail on the underlying GDP components, national statistics agencies highlighted some country-specific trends. According to France’s National Institute of Statistics and Economic Studies (Insee), French GDP stagnated due to weakness in domestic demand: Household consumption fell -1.3% q/q, with hotel and restaurant services (-5.3%) and goods purchases (-1.7%) detracting most.^[vii] That weakness appears related to early-year COVID restrictions when Omicron topped headlines. Now, these hard data may appear inconsistent with the message from purchasing managers’ indexes (PMIs), especially since France’s services PMI showed expansion from January – March.^[viii] But PMIs reveal the breadth of growth, not its magnitude—other services industries expanded, but perhaps not enough to offset the weakness in COVID-impacted industries. As Insee also noted, both transport services (1.9%) and services to households (0.5%) grew, albeit at much slower rates than Q4.^[ix] 

Germany’s Destatis provided fewer details than its French counterpart, but the agency attributed Q1 growth to higher capital formation (which includes domestic investment and changes in inventories) and noted the trade balance (exports minus imports) weighed.^[x] Future estimates should provide more color, as some of these GDP components are subject to interpretation. As we noted in our commentary on US GDP, inventory changes aren’t automatically good or bad. For example, if inventory change adds to GDP, companies may be stockpiling in anticipation of demand (good) or businesses could be having trouble moving product (not so good). In our view, the former is more likely as demand for limited goods—strained by supply chain issues—still appears strong. Similarly, if the boost came from business investment, that would also be a plus. Destatis also noted the Russia-Ukraine war has added more short-term unknowns, which may subject results to larger uncertainties than usual.

The limited amount of hard data didn’t prevent experts from publishing a raft of dour takes, with most coverage hitting on the same themes: War-related disruptions will push high energy prices higher, putting Europe in an energy crunch and making recession inevitable. However, the dominant skepticism overshadowed some better-than-expected realities. Take Germany. Over the past couple weeks, many experts warned the eurozone’s largest economy would contract again in Q1—putting the country in a recession according to one popular definition. Official numbers confirmed that didn’t happen, but many seemed to put that better-than-anticipated result on the back-burner and focused instead on France and Italy’s worse-than-expected GDP readings.

To be clear, we aren’t dismissing the Continent’s economic headwinds. The inflation rate is likely to remain elevated for a while, weighing on both businesses and households—and we sympathize with those suffering related hardships. But many of today’s dire projections are extrapolations of worst-case scenarios—e.g., the EU or Russia suddenly severing energy ties, leaving the Continent short on supply. Yet as we have highlighted recently, reality is more complicated than that. Moves against Russia thus far are small, and future, larger potential EU moves are also likely to be gradual—if they can overcome some members’ (Hungary, Austria) objections and actually implement an energy embargo. Despite politicians’ tough talk, there are many unsettled details regarding a potential EU ban of Russian oil—not to mention unknown implementation timelines. Even so, Europe is finding energy elsewhere: see natural gas exports from the US, Qatar and maybe even the UK. While these aren’t a perfect substitute for Russian energy, the alternatives do cushion the blow. Moreover, the available economic data suggest eurozone businesses continued expanding as Q2 got underway despite the war raging on. We see few signs this regional conflict is morphing into a larger one capable of engulfing the eurozone economy, let alone the global one. 

We are watching the situation closely as war and politicians’ responses to it are inherently unpredictable. But given how widely discussed a eurozone recession is at this point, markets have likely pre-priced some economic weakness. Recent eurozone returns underscore that.^[xi] In our view, that also queues up some positive upside surprise should reality turn out slightly better than the doom and gloom widely expected today.