Report on the Economic Situation of the Eurozone
Welcome to the 15th edition of Newsletter Basque Macroeconomics 5.0 published by Web 2.0: Basque Economics Worldwide Leadership
Introduction
The Eurozone has experienced a complex set of economic challenges and transformations during 2024, driven by both internal and external factors. Among these are the evolution of supply and demand, labor market dynamics, price fluctuations, and expectations surrounding the monetary policy of the European Central Bank (ECB). The following is a detailed analysis of these aspects, providing a comprehensive overview of the current economic situation and its potential implications.
1. Demand in the Eurozone
The demand for goods and services in the Eurozone has shown a moderate and, in many cases, weak trajectory in recent months. Retail sales in July 2024 reflect a slight 0.1% monthly increase, though this growth remains modest when excluding key components such as fuel and food. However, a significant limitation in this analysis is the lack of updated data from Germany and Italy, complicating a more precise evaluation of consumer behavior in the region's major economies.
Despite improvements in real consumer incomes, spending remains cautious. This is reflected in the downward revision of household spending in the second quarter, with a 0.3% annualized decline. This slowdown in consumption contrasts sharply with the wage gains recorded over the same period, suggesting that households, although seeing an increase in purchasing power, have opted for more conservative spending patterns.
In terms of investment, the situation is similar. Fixed investment was also weak in the second quarter, falling 0.6% excluding Ireland. This decline was driven mainly by reduced spending on equipment and construction, reflecting business pessimism and tighter financial conditions. Additionally, the impact of weather on the construction sector, which contracted by 3.9% in the second quarter, added another layer of complexity to already weakened business investment.
Overall, Eurozone growth in the first half of 2024 was 1.2% annualized, though the second quarter showed a significant slowdown with 0.8% growth compared to 1.3% in the first quarter. Weak internal demand is a key factor explaining this deceleration, and prospects suggest this trend is unlikely to improve significantly in the short term.
2. Supply and Productive Capacity
On the supply side, manufacturing activity continued to weaken in the second quarter of 2024. Although the decline was less pronounced than in previous quarters, manufacturing production remains a major drag on Eurozone growth. This situation points to a further slowdown in the global manufacturing industry, impacting the Eurozone given its key role in international supply chains.
The services sector, on the other hand, remains the main driver of growth in the Eurozone, with a 1.4% annualized increase in the second quarter. Services have remained resilient against the challenges facing the manufacturing sector, partly driven by the revival of tourism and increased consumption of digital and financial services. However, this growth has not been enough to fully counterbalance the weakness in industry and construction, resulting in more moderate economic growth.
Eurozone exports also face significant pressures. China’s impact on European manufacturing exports has intensified in recent years. China's shift from being a provider of intermediate products to an exporter of final goods has eroded European export market share in many key sectors. This has been exacerbated by the declining price competitiveness of European products compared to Chinese goods, due to rising production costs in the Eurozone, particularly in energy-intensive sectors like basic metals and chemicals.
3. Labor Market
The labor market in the Eurozone has shown mixed performance in 2024. On the one hand, employment has continued to grow at a solid pace, with a 0.8% annualized increase in the second quarter. However, this growth has been accompanied by a decline in productivity, leading to a increase in unit labor costs, which grew by 4.6% over the same period.
The slowdown in productivity has been one of the main factors behind rising labor costs, and although wage gains have been moderate, companies have struggled to maintain profit margins amid these cost increases. This context has added additional pressure on prices, although recent data show a trend toward stabilization.
It is important to note that despite the overall weakness in productivity, wage growth remains robust, driven by labor shortages in certain sectors and ongoing wage negotiations. Wage growth is expected to continue being a key driver of inflationary pressure in the short term, although this trend is projected to moderate in 2025 as the labor market adjusts.
4. Prices and Inflation
Price developments in the Eurozone have been a central issue in 2024. Headline inflation fell to 2.2% in August, with a decrease in energy prices being one of the main factors driving this moderation. However, core inflation, which excludes more volatile components like food and energy, remained relatively stable at around 2.8%, reflecting the persistence of internal inflationary pressures, particularly in the services sector.
The impact of the Olympic Games in Paris was a temporary factor that influenced the increase in service prices in France, but this effect is expected to dissipate in the coming months. Nevertheless, service inflation remains a concern for the European Central Bank, as it is a key indicator of internal price pressures.
The GDP deflator, a measure of prices across the economy, showed a slowdown to 3.0% year-over-year in the second quarter, down from 3.6% in the first, suggesting a relaxation of internal price pressures. This, along with a moderation in unit labor costs and declining unit profits, indicates that inflationary pressures may be starting to ease, albeit gradually.
5. Monetary Policy and ECB Expectations
The European Central Bank has adopted a firm stance in its monetary policy approach, aiming to control inflation while managing risks to economic growth. In its September 2024 meeting, the ECB is expected to cut interest rates by 25 basis points, continuing a cycle of quarterly cuts.
The ECB has indicated that while inflationary pressures persist in certain sectors, the progress towards price stabilization is sufficient to justify a policy of gradual cuts. Core inflation, expected to reach the 2% target by 2026, remains an area of concern, but the ECB is confident that the measures taken so far have been effective in moderating inflation expectations.
Growth forecasts for the Eurozone have been revised downward, with projected growth of 0.8% for 2024. However, the economy is expected to regain momentum in 2025, with annualized growth of 1.5%. The ECB has maintained a data-driven approach, meaning that future rate decisions will depend on the evolution of inflation and growth in the coming quarters.
Conclusion
The analysis of the Eurozone economy in 2024 reveals a mixed picture. While internal demand remains weak, with moderate household spending and limited business investment, supply faces challenges due to declining manufacturing output and external competition, especially from China. The labor market has shown resilience, but productivity remains low, leading to rising labor costs.
In terms of prices, inflation has begun to moderate, though service sector pressures persist. The ECB, aware of these challenges, has opted for a gradual approach in its monetary policy, with quarterly cuts aimed at balancing the need to control inflation without harming economic growth. As the Eurozone moves towards 2025, the key will be observing how these factors interact and whether the policies implemented are sufficient to restore sustainable growth and keep inflation under control.
Consultant & Speaker, Lean Quality Systems, Design Control, Process Validation, and Lean Manufacturing at Atzari
6moThat is called government
This is indeed a well-structured and presented article.