Eurozone economic outlook, June 2023

The Eurozone’s current economic situation and its outlook are being shaped by economic factors moving in opposite directions. On the positive side, the Eurozone managed to get through the winter without energy shortages and severe recession feared by many analysts. Labor markets have continued to thrive, stabilizing consumer expenditure, and economic sentiment has recovered. On the negative side, inflation remains stubbornly high, the interest-rate hike cycle is still ongoing, and geopolitical uncertainty remains high. As a result of these countervailing forces, very moderate growth in 2023 seems to be the most likely scenario.

Corporate and consumer sentiment shows signs of recovery

According to Organization for Economic Cooperation and Development data, the Eurozone’s GDP grew by 0.1% quarter on quarter in the first quarter of 2023. Among the major Eurozone economies, Spain (preliminary) and Italy both expanded by 0.5%, France by 0.2%, while Germany stagnated.¹ All in all, it would be safe to say that the Eurozone economy stagnated.

However, against the background of the gloomy expectations of a severe winter recession, widespread only a short time ago, the Eurozone’s economic performance may be considered good news. Current consumer and business sentiment indicators suggest that a recovery is underway. Both rebounded considerably from the very deep autumn lows and are now close to their long-term average, as the European Commission’s economic and consumer sentiment index shows.² However, it should be noted that behind the improved corporate sentiment are wide sectoral differences: Consistent with the global picture, the services sector seems to be doing better than the industrial sector.

The industrial sector suffers from weak orders and abating international demand. For example, new orders from the German manufacturing sector collapsed by more than 10% in March,³  the highest drop since the first months of the COVID-19 pandemic. This is especially worrying as the high backlog witnessed during the peak of COVID-19 has largely disappeared. As a consequence, the purchasing manager index (PMI) for the industrial sector in the Eurozone contracted. The PMI for the services sector, on the other hand, is in solidly expansionary territory, indicating an acceleration of the sector at a strong pace.⁴

Sentiment in the consumer sector is also on the way up. This is likely to be due to the fading energy crisis, even if inflation continues to depress real incomes. In general, consumer expenditure is supported by a robust labor market, which has worked as a stabilizing factor for the overall economic outlook. In fact, at 6%, the Eurozone has reached a record-low unemployment rate.⁵ 

Inflation and monetary policy: Game not over yet

The rate-hike cycle in the Eurozone started last July, and since then, the European Central Bank (ECB) has raised interest rates seven times—the last time in May to 3.75% for its main refinancing operations. Headline inflation has been receding from its peak of 10.6% in October and stood at 7% in April.⁶ The highest inflation, even if it is receding, is still to be found in the Baltic states (rates of 15% and higher), with wage costs being one key driver. Countries such as Belgium and Spain have inflation rates between 3% and 4%. Inflation in other big Eurozone economies is hovering in between these two extremes—6.9% for France, 7.6% for Germany, and 8.8% for Italy.

The rate-hike cycle is unlikely to be over, as underlying inflation dynamics are still strong. Core inflation (that is, headline inflation without food and energy), which is the key indicator of the spread of inflation across the economy, hardly shows signs of ebbing. In fact, it has been rising constantly. At 5.6% in April, it is only marginally lower than its peak the month before. As long as core inflation is not under control, the ECB’s fight against inflation is not over.