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An unusually large upward revision unexpectedly doubled the
Eurozone's Q1's real GDP growth rate to 0.6% q/q but economic
prospects remain challenging nonetheless.
At face value, the eurozone's real GDP growth rates in Q1 were
encouraging but a closer inspection of the expenditure data paints
a much less positive picture.
The higher than expected growth rate was driven by inventory
accumulation and a boost from net trade related to import weakness.
Domestic final demand contracted.
Various headwinds, including knock-on effects from the
Russia-Ukraine conflict and tighter financial conditions, will
weigh on economic activity over the coming quarters once pent-up
demand for some services wanes.
Energy-related disruptions threaten to tip the eurozone into
recession.
What lies beneath
Eurostat's third estimate of eurozone real GDP in Q1 delivered
an unusually large upward revision to the q/q rate of growth, from
0.3% to 0.6%. A deeper dive into the data beyond the headline
revision suggests a more sober assessment is appropriate.
First, the initial breakdown by expenditure painted a rather
worrying picture of domestic economic conditions.
Second, while on a y/y basis, eurozone real GDP growth rose from
an already very elevated 4.7% up to 5.4%, y/y rates of growth in
recent quarters have been flattered by base effects related to
COVID-19-related disruptions a year previously. Those base effects
will go into reverse in Q2 and Q3, resulting in a sharp slowdown in
the y/y rates of change.
Third, although following Q1's increase eurozone real GDP
surpassed its pre-pandemic level in Q4 2019 by 0.8%, the eurozone's
recovery from the COVID-19 shock has underperformed the US and
other advanced economies.
Fourth, Ireland's real GDP surged by almost 11% q/q in Q1, a
one-off rebound following a steep drop in the prior quarter,
powered by external trade. Domestic demand actually declined.
Excluding the exceptional contribution from Ireland, the q/q rise
in eurozone real GDP would have been less than half the reported
0.6%.
Domestic distress
The key takeaway from Q1's expenditure breakdown for the
eurozone was the key role of inventories and net trade in boosting
the q/q growth rate. Inventories contributed 0.6 percentage points
to the q/q rate of increase in real GDP. This followed a 0.4
percentage point contribution in the prior quarter.
Net trade contributed 0.2 percentage points to the q/q growth
rate in Q1. This was partly because imports fell by 0.6% q/q, the
first decline in seven quarters. Following Q1's data, exports
exceeded their pre-pandemic level in Q4 2019 by 4.1% but imports
were 0.1% below (see chart), consistent with weakness in domestic
demand.
That weakness in domestic demand in Q1 was broad-based. Eurozone
private consumption dropped by 0.7% q/q in Q1, the second
consecutive contraction. This left private consumption 2.7% below
its pre-pandemic level in Q4 2019.
Public consumption declined by 0.3% q/q in Q1, the first fall in
four quarters, though it remained 5% above its Q4 2019 level,
having been boosted by multiple support measures aimed at
countering the effects of the COVID-19 shock.
Investment rose only marginally, by 0.1% q/q, although this
followed a strong increase in the prior quarter. As of Q1,
investment was still almost 7% below its pre-pandemic level (see
chart). The breakdown of investment was, admittedly, more
encouraging. Machinery and equipment investment was strong (1.5%
q/q), as was construction (3.4% q/q), with the latter 4.5% above
its pre-pandemic level. Overall investment was dragged down by
weakness in intellectual property products which plunged in Q1
(-8.9% q/q) and remained over 30% below its pre-pandemic level.
Still, in sum, eurozone domestic final demand contracted by 0.3%
in Q1, the first fall in four quarters, and the outlook looks
challenging.
Beyond the bounce
Our current forecasts for annual real GDP growth in the eurozone
in 2022 and 2023 are 2.5% and 1.8%, respectively, below the market
consensus expectation in both years. We markedly reduced our growth
forecasts back in March following Russia's invasion of Ukraine.
While Q1's positive surprise suggests this year's growth rate could
actually turn out a little higher than forecast, we are
increasingly worried about 2023 and see the risks skewed to the
downside.
Private consumption is being hit by an ongoing extreme squeeze
on household real incomes as inflation rates soar, with consumer
confidence having weakened markedly to match the lows seen during
the COVID-19 shock and the GFC. While various factors, including
excess household savings and pent-up demand for some services, have
been cushioning the blow, the appetite to continue to run down
savings to consume is likely to wither.
Our own PMI data tell us that strong pent-up demand for the
services restricted by COVID-19 - travel and tourism, recreation -
will support growth near-term. However, that effect will fade after
the summer, when the eurozone economy will likely start to show the
adverse effects of a number of headwinds, including household
income constraints, persistent high uncertainty, tightening credit
conditions and higher energy costs. Simulations via our Global Link
Model suggest a sustained rise in oil and gas prices later in the
year could be the straw that breaks the camel's back, tipping the
eurozone into recession.
Posted 10 June 2022 by Ken Wattret, Vice President, Economics, S&P Global Market Intelligence
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.
