Sharp slowdown of growth in Europe: what will drive a renewed upturn?

Eurostat’s flash estimate of second quarter GDP growth shows a substantial and widespread slowdown in the rate of growth: compared with 0.8% in the first quarter, both the EU27 and the euro area expanded by just 0.2% in the second quarter.  Growth at an annual rate of just 0.8% (the above rates are quarter-on-quarter) is a recipe for stagnant or falling employment and for unemployment to rise from its already elevated level.

The decline was broad-based. Growth came to a virtual standstill in the two largest economies, Germany and France, which had seen strong expansion in the first quarter. The other large economies, Italy, the UK and Spain continued to bumble along at sluggish rates close to the EU average, while the Netherlands followed the Franco-German lead. Of the western European countries only Austria, Finland and Sweden performed well, all with quarterly growth rates around a robust 1%. In central and eastern Europe Slovakia continues to expand at a strong pace, while the bounce-back in Estonia and Latvia (but not Lithuania) continues, but needs to be seen against the prior dramatic output losses of the order of 20%.Others saw declines.

Estimates are not yet available for Poland, Greece and Ireland, among others.

Overall the figures are very disappointing. We are recovering from a deep recession. Growth should be above the trend rate in order to close the output gap, not below it. To see even a small crumb of comfort one is reduce to the schadenfreude that the USA is performing no better and Japan worse. There can be little doubt that an important cause of the slowdown is that the austerity policies that the European authorities and most member state governments clamoured for in 2010 are increasingly beginning to bite. Note that the second quarter ended in June, before the recent stock and bond market turbulence. With unemployment still high, capacity utilisation low, many households still paying off debt, fiscal austerity intensifying, commodity prices high (if falling more recently), the euro strong (unless you are Swiss), and now consumers and firms feeling the negative wealth effects of the stock market plunge, I do not see any reason to expect growth to pick up substantially in the third and fourth quarters. Unemployment is thus at best likely to stagnate at a high level into the coming year. When will the ECB accept that it was wrong to hike interest rates twice in the spring?

Concluding on a technical point, it is worth noting that while the flash estimates are very reliable for the European aggregates (EU27, euro area), figures for individual countries need to be treated with caution, as subsequent variations can be marked. In this case, notably, Greece’s first quarter growth was indeed ‘too good to be true‘: it has been revised down from an encouraging 0.8% to just 0.2%.