While the latest GDP figures outperformed expectations, leading indicators suggest the economy has slowed dramatically in recent weeks, raising the risk of recession in the second half of the year.
Quarterly eurozone real GDP growth accelerated from 0.6% in the first quarter to 0.7% in the second quarter of the year, beating consensus expectations of a slowdown to 0.2% growth (Schroders forecast 0.6%). On a year-on year basis, GDP growth slowed from 5.4% to 4%, as the gains from the rebound post-lockdowns start to fade.
Amongst the larger member states, Spain, Italy and France all beat expectations, while Germany disappointed. Spain was the best performer, growing 1.1% after growth of just 0.2% in the previous quarter, although Italy was close behind with 1% growth compared to 0.1% at the start of the year. France rebounded from its 0.2% contraction in the first quarter to growth of 0.6% in the latest period.
The main disappointment came from Germany, as growth stalled compared to expectations of 0.1% growth. However, it is worth noting that German GDP growth for the first quarter was revised up from 0.2% to 0.8%, and so the underperformance compared to the previous data is not as bad as it appears.
As these are preliminary figures, there are few details of the drivers of growth. France, which does provide some details, saw growth coming from net exports, mostly driven by weaker imports. Domestic demand was flat overall, as household spending contracted yet again. It seems that higher inflation is reducing demand from households, which is hurting growth. But with inflation rising further, could this the last of the solid growth for the eurozone?
Inflation hits another record high
Meanwhile, monthly HICP inflation for the eurozone rose to 8.9% y/y in July based on the latest flash estimate. Headline inflation rose from 8.6% y/y in the previous month and was mainly driven by higher prices for processed food, alcohol and tobacco, along with services. Core inflation, which excludes energy, food, alcohol and tobacco rose from 3.7% to 4%.
The details of the report suggest that external factors, such as food and energy, continue to dominate the basket of goods and services with regards to higher inflation. However, the rise in services inflation does suggest that domestic pressures are also building. This is especially concerning as unemployment rates remain close to record lows, raising the prospects for higher wage settlements and a further rise in inflation pressures.
Moreover, concerns over the supply of natural gas from Russia has raised the cost of energy for this winter dramatically. Member states recently agreed to a voluntary 15% reduction in the consumption of gas, but this could become mandatory if supply continues to be disrupted. While energy inflation fell back from 42% y/y to 39.7% y/y in the latest reading, we expect further price increases to keep energy and headline inflation elevated in the second half of this year, which in turn will reduce the spending power of households.
Recession risks rising
While the latest GDP figures outperformed expectations, leading indicators suggest the economy has slowed dramatically in recent weeks. The S&P Global purchasing managers indices (PMIs) suggest activity is now falling, raising the risk of recession in the second half of the year.
We continue to expect reasonable growth for southern member states, which have not enjoyed a full tourism season since 2019. However, it’s clear from Germany’s performance that global capital investment has slowed in response to rising interest rates and concerns over growth. China’s draconian lockdowns have not helped matters either. With the heavy reliance on Russian gas to consider as well, it appears that the northern member states are particularly vulnerable going into the next two to three quarters.