Last week’s release of the latest estimate of first quarter GDP indicates that the euro area fell into a technical recession. Growth of -0.1% during the quarter followed a revised decline of the same magnitude in the final quarter of 2022. In the context of forward-looking markets, whether growth in a particular quarter was 0% or -0.1% is, to us, not critical, particularly since this data is now more than two months stale. Regardless, what is clear is that the current economic growth impulse in the euro area is anaemic. Consensus expects growth for calendar year 2023 to be just 0.6%.

Still, the Eurozone has avoided the much gloomier economic outlook predicted for it as recently as January. At that stage, consensus GDP growth was -0.4% for fourth quarter 2022 and first quarter 2023. The decline in the price of gas can take much of the credit for this improvement, even if it continued to weigh on activity in absolute terms. Despite gas prices having now substantially normalised, significant headwinds remain for the euro area economy.

Foremost among these headwinds is the tightening of monetary policy and its likely impact on domestic demand. Euro area policy rates are currently at their highest level since 2008 and the market is still pricing in just shy of two more hikes from the European Central Bank, with a 25-basis point hike expected on Thursday. The impact of this tightening can already be seen in the lending data, where corporate borrowing has been negative in five of the last six months and mortgage lending has slowed meaningfully. This is also starting to manifest in economic activity, where recent declines in industrial production and retail sales see both metrics little changed from late 2020.

With further removal of fiscal support expected, the governmental sector looks unlikely to be the marginal source of economic growth. As we expect global growth to be lacklustre, this also means that the export sector cannot be relied upon to pull the region out of its current slowdown, given probable weak global demand. China’s belated post-COVID reopening is one potential countervailing bright spot.

Given Europe’s peers face broadly similar growth challenges of their own, euro area economic or markets underperformance is not inevitable. By the same token, however, it is hard to be enthusiastic about the prospects for regional outperformance, at least in the near term. As a result, we recommend continuing to hold euro area assets in line with benchmark weights.

Thomas O’Mahony, Senior Investment Director, Capital Markets Research