How bleak are the euro zone’s development prospects?

Growth prospects in the Eurozone have been particularly volatile in recent quarters. The region quickly shifted from post-pandemic reopening to a “crisis economy” after the Russia-Ukraine conflict began.

In fact, the Bloomberg Consensus forecast for Eurozone GDP growth in 2022 has been sharply revised from 4% to 3% in the months since the war in Ukraine broke out, with the prospect of a deep and persistent recession in late and early 2022. 2023.

Indeed, there is little precedent for the scale, scope and depth of adverse shocks affecting the region. On the supply side, the legacy of pandemic-related disruptions has been reinforced by the most significant energy crisis in decades.

The geopolitical fallout from the Russia-Ukraine conflict has materialized in embargoes, sanctions and trade bans, which have adversely affected Europe’s utilities and energy-intensive industries.

On the demand side, the strong momentum of the post-pandemic economic recovery has begun to wane as high and rising inflation dampens disposable incomes, weighing on consumer and business sentiment.

As a result, the Eurozone was severely affected by the difficult combination of slow growth and high and rising inflation.

Consensus forecast for the Eurozone in 2022
(From January 2021 to December 2022; y/y, %) / Sources: Bloomberg, QNBc analysis

However, despite the challenges, the Eurozone has so far been more resilient than most analysts expected, especially those expecting a deep and lasting recession.

In this article, we look at three factors that explain the resilience of the eurozone economy.

First, the Eurozone has consistently beaten expectations over the past few months, with data still pointing to a robust and expanding economy. In fact, the region beat most forecasts, recording annual growth of 4% and 2.1% in the second and third quarters of 2022, respectively.

This solid performance was supported by personal consumption spending, a strong summer season for tourism and services, as well as post-Covid inventory growth. Moreover, although high-frequency activity data such as the PMI has been weak for months, it is starting to show the first signs of stabilization.

This suggests that the fundamentals of the European economy were stronger than previously thought, especially in relation to the labor market and household consumption.

TTF natural gas prices in the Netherlands
(normalized to 100 in January 2022) /
Sources: Bloomberg, QNB analysis

Second, the outlook for the European energy crisis this winter has improved markedly, allowing for more stable industrial production and less severe utility consumption.

The positive developments seen so far are due to milder winters on average, more efficient energy saving mechanisms, higher gas reserves last summer and more stable regional energy production.

Crucially, Dutch TTF natural gas prices, the benchmark for Europe, have reversed much of the historic rally that began in the summer when Russia announced it would no longer export gas to Europe via the Nord Stream pipeline.

More affordable gas prices relieve both households and governments due to lower utility costs and reduced budget commitments for energy subsidies, which boost disposable incomes.

Thirdly, the policy implemented this time also lays the groundwork for growth in the euro zone. In contrast to previous economic crises in the Eurozone, there are few fundamental differences regarding potential support measures if new risks materialize.

There is little appetite for overly tight fiscal discipline, as even countries such as Germany, Austria and the Netherlands, which have historically run persistent budget surpluses, are now running deficits. This is due to the need to finance energy subsidies and direct transfers to cash-strapped households, utilities and businesses. In other words, budget deficits are now commonplace in the eurozone.

Therefore, there is a consensus on urgent budgetary measures and even urgent support from the European Central Bank (ECB). This should provide the necessary institutional safety net for further policy action if required.

Overall, the economic challenges are significant and the outlook for the euro area is still quite difficult. A regional recession for Q4 2022-Q1 2023 is almost a given.

However, the deep recession expected by some analysts should be avoided. Stable fundamentals, a better managed energy crisis this winter and greater political unity offer some comfort and support. This should allow the Eurozone GDP to grow by 0.5% in 2023.

(QNB economic analysis)

Leave a Reply

Your email address will not be published. Required fields are marked *