A testing time for Europe

13 November 2023

Please note: All data referenced in this article is sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing. 

The eurozone has faced another difficult year in 2023, recording only limited growth over the past 12 months. While its economy as a whole has managed to escape recession, Germany – traditionally the main driver of the region’s growth – has slipped into decline. The German economy has been hit especially hard by the energy supply disruption caused by war in Ukraine, and weaker demand from China.

While the energy crisis has eased, the slowdown in global activity, especially in the manufacturing sector, remains a concern for a region that depends heavily on exports. Add to that worries about rising government debt and potential stagflation (high inflation combined with low growth), and the outlook for the year ahead remains challenging. On the positive side, the benefits of the Next Generation EU (NGEU) €800 billion recovery package could start to feed through, after the slow initial uptake.   

Recession risk looms

With interest rates expected to remain high throughout 2024, growth of just 0.4% is forecast across the eurozone next year, similar to 2023 levels. The risk of a recession continues to loom, but if it does materialise, any downturn is likely to be relatively mild.  

At a country level, most of the region’s major economies are on track for lacklustre growth of below 1% for the year ahead. Germany is likely to move out of recession, but only marginally, with just 0.2% expansion on the cards. The prospects for Spain remain more promising – after benefiting from a surge in tourism this year, the country is now set to reap the rewards from being the main recipient of NGEU funding so far. 

Inflation pressures persist

The European Central Bank (ECB) continues to battle with inflation, but faces the added challenge of balancing differing circumstances across EU member states. In France, for example, consumer prices (harmonised) rose by 5.7% year-on-year in September, whereas in the Netherlands, prices fell by 0.3% year-on-year.  

However, inflation across the eurozone is expected to fall back in 2024, to 2.8% on average, compared to nearly double that in 2023. The ECB may be comfortable allowing inflation to remain above its 2% target, given the forecasts for a weaker economic backdrop. 

Challenges ahead

The prospect of elevated inflation and low growth brings the threat of stagflation, and governments will likely need to provide fiscal stimulus to avoid it. However, some countries are in a better position to spend than others, and with investors increasingly concerned about national debt levels, governments who overstretch could come under pressure in financial markets. Volatility in sovereign bond spreads is therefore a real possibility in the months ahead.  

Energy prices remain a key risk for the region’s economy, especially as we move into winter, and given ongoing geopolitical tensions. While the bloc is much better prepared than in 2022, with gas storage reaching 98%, higher prices could stoke inflation and undermine growth. 

Lastly, the sharp decline in manufacturing globally has been a significant factor in the eurozone’s recent slowdown. There are hopes that this could be a temporary readjustment following the post-pandemic surge in activity. However, a more sustained manufacturing downturn, combined with a likely slowdown in the services sector, could prove challenging. 

Related articles