Macro – Eurozone

Can it get any tougher for Europe?

13 November 2023

Julien Lafargue, London UK, Chief Market Strategist

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

The last twelve months have been another challenging year for the eurozone. While, on aggregate, the bloc avoided a recession, growth was muted. Germany was caught in the eye of the storm and, after being the engine of growth for the region, has become its sick man. 

Indeed, the country’s business model in recent decades has relied on access to cheap Russian energy and exports to the Far East, both of which are now being challenged with the Ukrainian war and the lack of a recovery in China.

While the energy crisis has abated in 2023, other challenges remain. First, the region’s dependence on international trade is suffering as the rest of the world hasn’t been immune to the macroeconomic slowdown, particularly on the manufacturing side. Second, with financial markets increasingly focused on government deficits and national debt levels, worrying memories of the 2010 sovereign debt crisis have started to resurface.

With inflation still problematic, the risk of stagflation can’t be ignored. The silver lining could come in the form of increased spending from the €800 billion Next Generation EU (NGEU) recovery package, which, after a slow start, could finally pick up in 2024. 

Flirting with recession

With monetary policy likely to remain restrictive for most of 2024, the bloc’s gross domestic product (GDP) is forecast to expand by just 0.3% (see table), roughly in line with the pace seen in 2023. With growth so weak, and the economy being close to stagnation, there is the risk that a small accident tips the eurozone into recession. However, should this occur, any contraction would likely be relatively mild.

Europe economic forecast, year on year (%, F = forecast)

  2022 2023F 2024F
GDP growth 3.4 0.5 0.3
CPI inflation 8.4 5.6 2.8
Unemployment rate 6.7 6.5 6.7
Gross public debt (% of GDP) 93.2 92.0 93.6
Private consumption 4.2 0.3 0.5

Source: Barclays Investment Bank, Barclays Private Bank, November 2023

Within the eurozone, most major countries appear on course to grow by less than 1% in the next twelve months. Even after contracting in 2023, the recovery in Germany should be minimal, with the country’s GDP set to expand by just 0.2% next year. On the other hand, the Spanish economy should continue to outgrow its peers. That said, the main driver of this performance should shift from the recent tourism boost, to the benefits of having been the main user of the NGEU grants so far.

Inflation to stay above target 

One of the challenges facing the European Central Bank (ECB) is the wide disparity of inflationary pressures evident among EU members. While the Netherlands saw prices drop year on year (Y/Y) in October (-0.4%), France’s harmonised index of consumer prices was still running at 3.9% Y/Y. This makes it difficult to fine-tune monetary policy and increases the risk of the authorities getting policy wrong.

Overall, eurozone inflation should ease in 2024, averaging 2.8%, nearly half of that seen in 2023. While this is still above the ECB’s 2% target, the central bank may be willing to tolerate this overshoot in the context of a bleak growth outlook and weak consumption, despite historically strong wage growth.

With growth so weak… there is the risk that a small accident tips the eurozone into recession

Potential flashpoints

With the ECB aiming to keep interest rates elevated for as long as possible in the fight against inflation, escaping stagflation will require fiscal support. On that front, disparities among the growth dynamics of EU members will cloud policy again, and we would expect financial markets to police governments that spend more than they can afford. As a result, increased spread volatility on sovereign bonds seems to be a real risk in the coming months.

Energy prices will be another key factor to consider when assessing economic prospects for the eurozone. While gas storage is 98% full and in a much better shape than it was this time last year, geopolitical tensions and a colder-than-expected winter could revive the inflationary impulse and weigh on the bloc’s growth prospects.

Finally, part of the region’s weakness of late can be attributed to a global slump in manufacturing activity. This could just be the payback from a pandemic-related boom and, if so, a rebound may be on the cards for 2024. However, if this rebound does not materialise, at a time when services activity is likely to slow, the bloc could find itself gasping for air. 

Outlook 2024

What’s in store for investors in 2024? Despite lingering uncertainty and volatility, find out why it’s not all doom and gloom.