Europe’s economic growth is extremely fragile
When an economy contracts for two consecutive quarters, it is often considered to be in recession. European policymakers will be hoping that two consecutive quarters of growth are equally notable. Data released on August 14th showed that, in the second quarter of the year, the EU’s economy once again grew by 0.3% against the previous quarter. Although nothing to write home about by American standards, such growth is a relief after more than a year of stagnation.
The good news does not stop there. Employment is growing, albeit more slowly than before. Wage growth is outpacing inflation, too, leading to rising living standards. In the Netherlands, which has the continent’s most up-to-date labour-market data, centrally negotiated wages rose by 7% in July, twice the pace of inflation. Union-negotiated wages are similarly strong in Germany. Nevertheless, the European Central Bank (ECB) still felt confident enough to cut interest rates in June, and is expected to do so again in September.
Full speed ahead, then? Not quite. The continent faces a number of risks—any of which could make the picture much gloomier. The first is that demand does not look as healthy as growth figures might suggest, as is illustrated by the construction industry. Rents are rising in many of Europe’s most alluring cities: Athens, Berlin and Madrid are all seeing growth of about 10% a year. On top of this, interest rates are falling, which should boost property prices. Yet housebuilder confidence is now at the lowest it has been this year, for reasons that are not immediately clear.
Growth in incomes should also be boosting consumption. In reality, however, “we are yet to see any meaningful pickup in real domestic demand,” observes Clemente De Lucia of Deutsche Bank. Households are mostly putting the additional money from higher pay into their savings accounts, he adds. In time, a cooling labour market could further reduce the desire to spend. As Davide Oneglia of TS Lombard, a consultancy, notes, hiring has weakened in services, which has been the main source of jobs in recent years.
Governments are unlikely to support demand with extra spending of their own. Germany’s has once again almost torn itself apart over the legal intricacies of its balanced-budget rules. Negotiations are ongoing, but the result is likely to be spending cuts. France and Italy, meanwhile, are both in an “excessive deficit procedure”, which the European Commission reserves for the most blatant violators of its guidelines. As such, fiscal policy will be a drag on growth in the years to come.
The next worry concerns a single country: Germany. It has barely grown since 2019. More recently, its exports fell by 4.4% in June on a nominal basis, compared with a year earlier, and surveys indicate that worse is to come. Industrial companies that have failed to modernise now face a bigger challenge from China, as low-cost electric vehicles (EVs) pour out of its factories. Germany’s long-term prospects are also concerning: other than Lithuania, no country in the OECD is set to lose more workers to retirement, relative to new entrants into the labour force. The country is big enough that its economic woes will also drag on Europe’s growth.
The continent’s trading partners will not come to the rescue. American demand, though enviable, is starting to weaken and China’s economy is in a mess, which officials are hoping to fix with manufacturing subsidies. If Donald Trump is elected, trade wars—both transatlantic and between America and China—will worsen the situation. Europe’s conflict with China is already under way, as the country prepares to sue the EU at the World Trade Organisation for raising tariffs on EVs.
As it stands, Europe appears to be pulling off a soft landing, even if its economy never truly soared in the first place. Inflation has fallen to 2.5%, just above the ECB’s target, and the continent has enjoyed two consecutive quarters of growth. But the euro zone’s policymakers would be wise not to take too much cheer from this. Plenty of dangers must first be navigated before the celebrations can begin. ■
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