While all signs point to the European economy recovering, there are still some problems that need long-term solutions.
Rising growth, low unemployment numbers and normalizing inflation are a good sign, but weak investments, higher energy prices and geopolitical tensions mean more work needs to be done in the long term.
According to an analysis by Bill Papadakis, Senior Macro Strategist at Lombard Odier, demographic ageing and a weak manufacturing sector in Germany are some of the problems that will continue to persist and will need long-term solutions.
Rising growth
In the first quarter of 2024, the euro area gross domestic product (GDP) grew at an annualised rate of 1.3 percent. This was identical to the growth rate seen in the US. Not only that, it was significantly better than Europe’s growth in the previous quarters. Purchasing Managers’ Index surveys, too, are showing improvement.
All these indicators are signs that the European economy has further room to grow, the analysis said.
What’s working?
Improving economic fundamentals such as growth in real household incomes because of increase in employment, wage growth and falling inflation are some trends improving consumer confidence.
“These trends coincide with improving consumer confidence, suggesting that after a long period of high saving rates, European consumers may now turn more willing to spend,” the analysis said.
Things will get better
While financial conditions remain restrictive in the euro area, their peak effect is probably several months behind us. Lending to the real economy has started to pick up again. Rate cuts by the European Central Bank are likely to improve credit conditions further. The combination of improved spending power, rebuilding confidence, and easier financial conditions bodes well for near-term growth prospects after the deep shocks of the past few years.
Rate cuts on the horizon
With headline inflation receding from its double-digit peak in late-2022 to the mid-2 percent range currently, ECB policymakers look all set for their rate cut on June 6, Papadakis wrote.
“Currently, interest rate futures pricing indicates a scenario of only two 25 basis point cuts, possibly reflecting concern with signs of stickiness in services inflation. But with no signs of a wage-price spiral, well-anchored inflation expectations, normalising wage growth, and still-anaemic domestic demand, we think that inflation persistence concerns in the euro area are exaggerated,” the analysis said, anticipating that the central bank will ease rates at least three times this year.
Structural challenges remain
While the much-needed upswing has arrived, some long-term challenges remain.
For instance, recent growth has been driven by net exports, while domestic demand has remained weak. Investment, too, is below its 2019 levels. Then, there’s the spillover from geopolitical risks, including higher energy prices and increased tariff barriers, which can have a negative impact on European growth.
One country that stands out with its challenges is Germany. Its growth has underperformed the rest of the euro area. The manufacturing sector is particularly weak, given the impact of the energy shock and German industry’s high exposure to China.
Next Generation’ EU funds, Europe’s recovery instrument, have helped economic recovery. But with fund disbursements set to peak this year, and end by 2026, the impulse to growth may diminish.
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