Yesterday’s dismal eurozone Q2 GDP results appear to show the fragile recovery derailed. Real GDP growth for the bloc was flat at 0.0% quarter-on-quarter. The most notable results were the negative growth in the eurozone’s largest economy – Germany – and also it’s third largest Italy – which is now in the midst of a triple dip recession. Meanwhile, France – the second largest economy – saw flat growth.
Quarter-on-Quarter Real GDP Growth in the Eurozone: Q2 2014
Source: Eurostat
Note: Q2 data for Ireland, Greece, Luxembourg, Malta and Slovenia have yet to be released
What Does it Mean?
One thing is clear, the performance of the eurozone is heavily dependent on its largest economies. Germany, the engine of growth, accounted for 28.5% of total GDP in 2013 and France, Germany and Italy combined accounted for two-thirds of the eurozone economy. Germany’s weak performance in Q2 was due in part to one-off factors including a mild winter that led to a much stronger than expected performance in Q1. France meanwhile, saw its second consecutive quarter of flat growth as it continues to struggle with high unemployment and a high budget deficit and is in need of structural reform. The peripheral economies surprised on the upside but because of their small (with the exception of Spain) size this was unable to offset the weak performance of the larger economies.
Downside Risks Abound but Growth Momentum to Return in Q3
These results are undoubtedly disappointing and downside risks have increased. The most notable of which, is the increasing uncertainty stemming from the Ukraine crisis and escalating tensions with Russia, which have an impact on confidence and growth. For instance Germany’s exports to Russia were down 15% in the first five months of the year compared to the same period in 2013.
The threat of deflation also hangs over the eurozone with inflation falling further to just 0.4% year-on-year in July – the lowest annual inflation rate since October 2009. Deflation is a risk as it could lead to a vicious cycle of consumers delaying purchases as they expect prices to fall, depressing demand and deterring business investment.
Year-on-Year Change in Inflation in the Eurozone: January 1999 – July 2014
Source: Eurostat
Note: Data refer to all 18 current Eurozone member states
However, all things being equal, we expect the eurozone to return to positive growth in the third quarter. This will be driven by the removal of one-off factors such as the mild winter and stronger industrial production. Yet the escalating situation in Ukraine and the threat of deflation still have the power to lead the currency bloc back into recession.