After summer heat, economic chill – POLITICO

BRUSSELS — While Europe counts the cost of wildfires and record high temperatures, governments are facing up to a decidedly frosty fall and winter.

Buffeted by rising borrowing costs and a decline in business and consumer confidence, the eurozone economy is weakening rapidly. Interest rates this week were increased to record-equaling levels, inflation is falling but remains stubbornly high, and, on Friday, there came a fresh warning from the European Commission about the sluggishness of growth.

It all adds up to a bleak picture that suggests the cost-of-living crisis triggered first by the fallout from the COVID pandemic and then by Russia’s invasion of Ukraine will seep into the winter, making life difficult for millions of European citizens and putting pressure on political leaders from Paris to Berlin and Brussels.

“After stagnating at the start of the year, growth is likely to remain subdued” over the course of the year,  EU Economy Commissioner Paolo Gentiloni acknowledged at a conference in Salzburg, Austria, on Friday. When it comes to the 2023 forecast for the eurozone that he will present in September, it’s likely to be less optimistic than envisaged even as recently as June, he said.

A decisive ‘maybe’

The August getaway starts with, at 3.75 percent, interest rates in the eurozone as high as they’ve ever been. They’ve gone up faster than at any time in the European Central Bank’s 25-year history, too, making life tough for borrowers and suffocating growth.

On Thursday, ECB President Christine Lagarde suggested the increases might be halted — but then again, maybe not.

“There is the possibility of a hike, there is the possibility of a pause, it’s a decisive ‘maybe,’” she said of what the Bank might do when it meets next, in September. “But don’t expect me to go one way or the other 1690615322.”

Central banks raise interest rates to encourage businesses and households to save more and spend less. That almost always slows economic output.

The unprecedented rise in rates over the past year has started to bear fruit on the inflation-front: At 5.5 percent in June it’s down to nearly half its October peak.

Yet it’s come at a cost: loan demand by businesses dropped to an all-time low in the second quarter, according to an ECB survey of lenders. Demand for credit from households also slumped. And because of the inevitable lag between raising rates and seeing their full impact, analysts predict that the full-blown effect of monetary tightening is yet to be seen.

“The ECB’s hiking campaign is already causing economic damage,” Ann-Katrin Petersen, Senior Investment Strategist and Director at the BlackRock Investment Institute, said, adding that she fears that it risks “making a recession in following quarters likely.”

Sick man of Europe

Much of the data points in one direction: downward.

The eurozone economy shrank in the last quarter of 2022 and only avoided contraction in the first quarter of 2023 because of a statistical quirk in Ireland. GDP data for the next three months of this year, to be published on Monday, is unlikely to offer much to celebrate. There was one bright spot on Friday: The French economy rose 0.5 percent in the first quarter of 2023, although this was largely thanks to the delivery of a large cruise ship.

Gentiloni’s signal on Friday suggested the Commission’s forecast for growth this year, to be published on September 11, will be less positive than the estimate of 1.1 percent made in June.

The latest Eurozone economic sentiment indicator — a key index of business and consumer confidence — shows a further deterioration in July, down -0.8 points to 94.5 (with 100 being the long-term average). This was led by a strong decline in France (-2.3), and Germany (-2.1), whereas Spain, Poland and Italy stayed in positive territory. Employment expectations deteriorated further, by -1.8 points in both the EU and eurozone.

This week, the International Monetary Fund revised its global growth forecast slightly downward, while it marginally improved the eurozone’s expected output growth for this year to 0.9 percent — a 0.1 percentage point increase.

Still, it put Germany in a mild recession — a datapoint endorsed by the Kiel Institute for the World Economy, which predicted output to contract by 0.3 percent this year. And with the bloc’s largest economy and its industrial powerhouse turning into the sick man of Europe, wider knock-on effects for demand across the continent are likely.

Worst averted

Despite the gloomy projections, it could have been worse. The single-currency area has performed better than imagined around a year ago, when the expectation of energy blackouts from a halt to Russian energy imports left governments bracing for a recession.

While the 20-country bloc dipped into negative territory for two consecutive quarters — technically a recession — this was much milder than expected, largely thanks to fiscal stimulus packages and EU funds which kept demand and employment levels high.

Filippo Taddei, Senior European Economist at Goldman Sachs, said the bank had recently revised down its 2023 growth forecasts, but was predicting “low growth rather than a recession.”

“Manufacturing weakness continues to be driven by a combination of tighter financial conditions, excess inventories, delayed effects from last year’s surge in energy prices and weaker industrial activity abroad (especially in China),” he said. “On the constructive side, the combination of falling headline inflation, firm wage growth and ongoing employment gains points to a notable improvement in real household disposable income and consumption.”