Europe’s economic outlook appears gloomy in comparison to the United States, with the euro zone facing a weak export-led economy, reduced borrowing, and increasing borrowing costs. This stands in stark contrast to the United States, where inflation is receding without a recession or significant job losses. This has led to differing fortunes for Christine Lagarde, president of the European Central Bank (ECB), and Jerome Powell, chair of the U.S. Federal Reserve.
In July, the U.S. inflation rate was 3.2%, while GDP grew by 2.1% year-on-year in the second quarter. In comparison, the euro zone experienced 5.3% inflation and a GDP growth of just 0.6%. The disparity between the two economies suggests that the aggressive tightening measures implemented by the ECB have been less effective in controlling inflation compared to the U.S. Federal Reserve’s approach.
The euro zone narrowly escaped a recession earlier this year, with the final three months of 2022 seeing a contraction of 0.1% in economic output. However, zero growth in the first quarter of 2023 prevented the technical definition of a recession by a slim margin. Nonetheless, the risk of a recession still looms.
The manufacturing sector, which contributes around a fifth of the euro zone’s GDP, is already shrinking. Factory activity fell at its fastest pace since May 2020, and while there was a slight recovery in August, it remains at levels consistent with a recession. Weak demand for exports from China and the end of the post-Covid consumption boom have forced European industrial firms to brace for further challenges. Germany, the largest economy in the euro zone, is expected to see a 0.3% decline in GDP this year, according to the International Monetary Fund.
The services sector, which accounts for the majority of the euro zone’s output, is also experiencing a decline. In August, it reached a 30-month low due to reduced demand for services like travel and entertainment. As governments withdraw fiscal support and consumers face higher prices and borrowing costs, services firms have faced their worst slump in new orders since May 2013.
The nine consecutive interest rate hikes by the ECB since last year have made credit scarcer and less desirable. This has resulted in the lowest demand for loans since the central bank began keeping records two decades ago. Benchmark interest rates are currently at their highest level since 2000, and banks are charging the highest interest rates for loans to companies and households since 2008 and 2012, respectively.
These challenging economic indicators may suggest that the ECB’s efforts are working to curb inflation. Euro zone inflation has halved from its peak of 10.6% in October 2022. However, prices are still rising at more than twice the ECB’s 2% target, and the central bank anticipates that they will remain above this level until at least 2025. Policymakers have hinted that even if interest rates stop rising soon, they will remain elevated for some time, further exerting downward pressure on the economy.
Despite these concerns, neither the ECB nor professional forecasters in the financial services sector expect a recession in the euro zone this year. The central bank predicts GDP growth of 0.9% in 2023, while economists polled by Reuters anticipate a 0.5% expansion in the bloc’s output.
A positive aspect of the euro zone’s economy is the low unemployment rate, which currently stands at a historic low of 6.4%. This is largely due to companies ramping up hiring to meet the surge in demand for goods and services following the Covid-19 pandemic. Approximately 3% of available jobs in the euro zone are currently vacant, nearing the record high of 3.2% reached in the second quarter of 2022. While a recession could lead to increased layoffs, the resilient job market suggests that a short and shallow downturn could potentially avoid mass unemployment. Additionally, European labor regulations and strong unions, which make it challenging for companies to dismiss workers during a recession, would help limit the damage.
Despite the potential for a short and mild downturn, the increased bargaining power of workers is resulting in higher pay, which poses a challenge for Lagarde and the ECB. Labor costs in the euro zone rose by 5.0% in the first quarter of 2023 compared to the same period in 2022, which is not conducive to bringing inflation back down to 2%. Europe faces a longer and more challenging battle to control rising prices.
Overall, the euro zone is grappling with a weak economy, reduced borrowing, and rising borrowing costs. The manufacturing and services sectors have been particularly impacted, with declining factory activity and reduced demand for services. While the risk of a recession remains, the low unemployment rate and labor regulations may help cushion the economy. However, the increased bargaining power of workers and rising labor costs pose challenges for controlling inflation. The ECB’s efforts to curb inflation have not been as successful as those of the U.S. Federal Reserve, and the euro zone faces continued economic
More detail via Reuters here… ( Image via Reuters )
