Recent data suggests the eurozone is gradually recovering, but underlines a state of economic divergence, with Germany in particular lagging behind southern Europe.
The downturn in the eurozone’s struggling economy is easing, according to the latest Purchasing Managers’ index data, which suggested that stabilising services activity is offsetting a steep decline in manufacturing — particularly in Germany.
S&P Global’s flash eurozone composite PMI, which measures business activity across the eurozone, rose to an eight-month high of 48.9 in February, up from 47.9 in January.
This is however the ninth consecutive PMI reading below the 50 mark, which separates contraction from expansion, indicating the eurozone economy remains stuck in a rut after stagnating for much of 2023.
Due to a lack of reliable and timely hard economic data for the eurozone, many economists and analysts rely on the monthly PMI and Economic Sentiment Indicator (ESI) numbers. Both these survey-based indicators have a strong record in tracking year-on-year GDP growth. The latest PMI data suggests sequential growth is recovering in the eurozone, but only mildly. This is consistent with our macroeconomic team’s forecast of a gradual recovery over the course of the year.
Divergence in the eurozone with southern Europe outperforming the north
The composite eurozone PMI data masks an increasingly diverging trend across sectors and countries. In February, the composite number rebounded quite vigorously in France, and it is now well above 50 in Italy and Spain. Germany, however, saw a further drop (from 47.0 to 46.1) on account of a further weakening in manufacturing.
The conclusion we draw from the February PMI data is that the eurozone is gradually recovering, mostly driven by a rebound in the services sector, despite a structural manufacturing drag.
The ECB will likely take this PMI release as a sign that monetary policy transmission has peaked, and that growth will be stronger despite still-tight monetary policy. However, while there has been a clear improvement in sentiment over the last few months, most indicators still point to contraction.
Our macro team expects eurozone economic activity to improve further, but only gradually, as the scarring from the energy shock on the European manufacturing sector has likely reduced medium-run growth prospects for the eurozone.
Germany’s economy still struggling
Robert Habeck, Germany’s economics minister, announced last week that the government’s forecast for growth in 2024 had been revised down from 1.3% to 0.2%. On this basis, the economy has effectively stalled. Mr Habeck described Germany’s economic situation as ‘dramatically bad’.
Germany was hard hit by Russia’s invasion of Ukraine due to the dependence of its energy-intensive industries on Russian gas. In addition, Germany’s reliance on exports made it particularly vulnerable to the current softness in global trade (and despite a relatively weak euro).
Germany may in fact have already slid into recession, according to the Bundesbank. The economy shrank marginally last year, contracting by 0.3% in the fourth quarter of 2023. In its latest monthly report, the Bundesbank said ‘stress factors’ would probably remain and economic output could therefore “decline again slightly in the first quarter of 2024”. Two negative quarters in a row would put Germany into a technical recession.
An improvement in economic conditions will likely require a period of stability and a vision for the future after the series of crises in recent years upsetting Germany’s economic model.
Currently, political leadership is lacking, with the partners in Chancellor Olaf Scholz’s coalition — Social Democrats, Greens, and liberals — holding views on economic policy that are almost diametrically opposed. This potentially creates widespread confusion as to where Germany is heading. The lack of a clear vision on what the economy should look like in 5-10 years leads to a feeling of insecurity among companies and households, undermining the desire to invest for the future.
Looking ahead
Germany’s Council of Economic Advisors, which the government consults on economic matters, forecasts the economy’s potential growth rate for the coming 10 years at just 0.4% per year.
One of the main factors of production handicapping the potential rate of growth is a decline in the workforce due to an ageing population.
This long-term growth challenge also confronts Italy and suggests the current outperformance of Italy’s economy may be temporary.
Challenging demographics
Ageing in Italy will occur much faster than in most other European countries, with the population forecast to shrink by 2-5% over the next 20 years. In contrast to Germany, few policy measures have been put in place to address this issue and opposition to immigration is still high in Italy.
Near term, rising participation rates may help offset the effects of adverse demographics on labour supply in Italy, and long term, artificial intelligence may come to the rescue, but final demand growth is already being hit. Potential growth will likely remain significantly lower than elsewhere as a result.
Disclaimer
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