European recovery: is it for real?

By Simona Paravani-Mellinghoff, Global CIO of Solutions, Multi-Asset Strategies & Solutions (MASS), at BlackRock

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

The European Union (EU) is finally experiencing a long-awaited rebound in economic activity. However, the pace of this revival differs across the bloc – countries such as Italy, Spain and Greece have recently demonstrated stronger growth than Germany or Sweden. Overall, EU GDP is expected to pick up in the coming months and inflation has moderated.¹

The question is whether the rebound will turn into a long-lasting recovery or just a false signal. The main factors at play illustrate a classic case of “the good, the bad and…the uncertain”.

Let’s start with the good news. From a cyclical point of view, with inflation in the euro area going down to 2.4% in April² – which is a significant improvement compared to the much higher levels of last year – the European Central Bank (ECB) is now increasingly likely to cut interest rates, possibly as early as June 2024.

Lower interest rates can foster growth in multiple ways. For example, they may help increase consumers’ spending power and create a much-needed tailwind for sectors affected by high interest rates. For example, the construction industry, which has been under pressure throughout the ECB’s hawkish cycle of the past 18 months, may bounce back in the second half of the year. The rebound in construction should also be supported by more structural factors like renovation works generated by the ongoing energy efficiency drive in Europe, stimulated by state incentives like “MaPrimeRenov”, a grant scheme dedicated to thermal renovation of private housing in France.

Another boost for the European economy may be triggered by re-stocking within industrial sectors, following a slump in their inventories caused by weak and uncertain demand last year. As inventories normalise, demand may go up, contributing to growth.

Furthermore, the prospect of the ECB cutting rates faster than the Federal Reserve on the back of stickier inflation on the other side of the Atlantic may also weaken the euro. This will help exports of goods and services, which account for half of the eurozone’s economy.³

But the broader macroeconomic landscape is still far from smooth sailing. The promising growth and inflation outlook is challenged by structural factors as well as geopolitical developments in a more fragmented world. Starting with the former, despite progress already made, more needs to be done to harness capital markets to unlock the full growth potential of Europe, in particular to face the challenges of the transition to a low-carbon economy and an even more digital world. On the geopolitical front, tensions in the Middle East could push the price of oil higher, potentially reversing the progress on inflation and adversely impacting growth.

However, geopolitical fragmentation and other mega forces reshaping global economies could also create opportunities for Europe – and that’s where the uncertain part enters the macroeconomic equation. Case in point: the trend towards reshoring to make supply chains more resilient may benefit Central and Eastern European countries. Additionally, the need to boost Europe’s defence capacity and advance the energy transition is likely to foster innovation and drive investments across the region.

The aging of populations poses a major challenge to the European economy, as it risks weighing on growth while potentially driving up inflation through higher public spending. On the other hand, the increased need for healthcare spending could create opportunities for investors. Research reveals that markets can be slow to price in the impact of even predictable demographic shifts.

Finally, artificial intelligence (AI) is often presented as a big unknown, but we see it as a potential game-changer, as it is gradually rolled out across the entire economy. It may boost productivity in the EU and help rein in inflationary pressures resulting from the other mega forces such as the rewiring of global supply chains and the low-carbon transition. 

As we look at 2024 and beyond, there are favourable cyclical factors that should support growth in Europe. And yet the broader macroeconomic context remains complex and uncertain so a lasting recovery can’t be taken for granted. This volatile environment is becoming the new normal so it is essential to be prepared for short-term fluctuations while aiming to harness the mega forces that will transform the European economy in the long-term.

Disclaimer

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of February 2024 and may change as subsequent conditions vary. There is no guarantee that any forecasts made will come to pass.