While growth in the euro area is recovering, geopolitical risks remain due to conflicts in Ukraine and the Middle East, as well as tightening financial conditions and changing political conditions across Europe.
advertisementS&P Global released its euro zone economic outlook for the third quarter of 2024 on Monday morning, highlighting that euro zone growth has rebounded, mainly due to lower energy and commodity prices.
That would lift gross domestic product (GDP) growth to 1.4% in 2025 from 0.7% this year, up slightly from the 1.3% forecast by S&P Global in March. Eurozone inflation is also expected to bounce back to the European Central Bank's (ECB) 2% target by mid-2025 if current conditions remain roughly constant.
A pickup in productivity, slowing wage growth and stabilizing profit margins should also help keep inflation in check, which is expected to average 2.2% next year from about 2.4% this year.
The euro zone economy also managed to achieve a mostly soft landing as a milder-than-expected winter last year had a knock-on effect on key sectors like construction. S&P also expects consumer spending to recover in the second half of the year as retail energy prices fall further, directly benefiting consumers.
However, the report also highlights increased risks of higher inflation, tightening financial conditions and slowing growth from March 2024 onwards.
The report also states that “geopolitical conflicts in the Middle East and Ukraine remain the main risks weighing on the near-term economic outlook. Apart from that, other risks have also increased in recent months. These relate to monetary policy decoupling on both sides of the Atlantic, political uncertainty in Europe and the deterioration of European-Chinese economic relations.”
What are the risks for Q3 2024?
Political instability is also a concern following the recent EU elections, with Sylvain Breuer, chief economist for EMEA at S&P Global, telling Euronews: “With the early French elections on everyone's mind, there will undoubtedly be more political uncertainty from the domestic fallout from the European elections than from the elections themselves.”
“They are a source of uncertainty and could certainly erode confidence and make the expected investment recovery in 2025 more fragile.”
Another major risk we may see in the coming months is the possibility of escalating tensions between the EU and China, mainly due to the EU considering tariffs on Chinese electric vehicles in order to protect and promote European cars.
“In terms of trade, China is Europe's second most important partner after the United States. It accounts for 10% of the EU's total exports and 22% of the EU's imports, around half of which are products of vital importance to the European economy,” the report said.
As for how far these tensions could escalate, Breuer said: “It's clear that Europe-China trade relations are deteriorating and will very likely get worse. I don't see this escalating into a full-blown trade war, and I don't expect EU-China trade relations to deteriorate as much as US-China trade relations have.”
This is because the European and Chinese economies are highly interdependent, with their respective supply chains far more intertwined than those of China and the U.S. For example, Europe certainly relies on China to import critical products such as solar panels needed for its green transition, but China also relies heavily on European technology not only for cars but also other transport and electronic equipment.
Around 15% of the value added by European companies in electronic equipment is exported to China, highlighting the high level of interconnectivity.”
There is also a growing risk that more European companies will withdraw from the continent's largest stock exchange to list elsewhere, such as in the United States or Asia.
“This clearly shows that European financial markets are too fragmented, too domestic and too costly for issuers and retail investors. Put simply, Europe needs to move forward with Capital Markets Union, which should surely be a top priority for the next Commission,” Breuer said.
Similarly, he believes it is important to streamline financial and other regulations so that European companies are actually supported and empowered to achieve the goals of the green transition.
As for what the European Union can do to attract more investment to the continent and retain companies wanting to move to the US and other markets, Breuer stresses that this is not just a matter of Europe wanting to win against external competition: It is also about returning the continent to the previous high productivity levels seen in past years.
According to Breuer, there may be some challenges for the ECB to continue its rate-cutting course in the near future.
advertisement“The ECB's needle is inflation and the central bank needs to see further progress in wage growth and services prices, the most domestic part of core inflation. Another factor that is becoming increasingly clear is the Fed. The longer the Fed waits and gives less guidance on when and how much it will start cutting rates, the harder it will be for the ECB to make further cuts.”
Breuer stresses that the decoupling of monetary policy between the ECB and the US Federal Reserve has become increasingly evident in the first three months of the year.
“European investors have already shifted $50 billion into the Treasury market and that will probably accelerate in the second and third quarters. So even if this issue of monetary policy decoupling is a minor issue for central banks in general, it is certainly one of the constraints for the ECB,” he said.
Why is Spain expected to experience strong growth this year?
The Spanish economy is expected to outgrow Germany in the third quarter for various reasons. The report highlights: “Falling energy costs have helped the German economy to emerge from recession in the first quarter of 2024, driven by a recovery in production in energy-intensive sectors such as the chemical industry. However, in terms of growth, the German economy still lags behind other major European economies.”
“Spain's GDP growth continues to outpace expectations, accelerating for the third consecutive quarter, reaching 0.7% q/q. This is not just due to the normalization of tourism after the pandemic: industrial production in Spain continues to expand. Consumer spending was the main driver of growth last year, accounting for 1% of Spain's 2.5% increase in GDP.
advertisement“The second-order effects on core inflation have also been more subdued in Spain than in many other countries. Another reason is the strong employment growth stimulated by labour market reforms aimed at replacing fixed-term contracts with open-ended ones. In contrast to the other three largest euro area economies – Germany, France and Italy – employment dynamism has not hindered productivity growth.”
