Southern growth spurt creates two-speed eurozone economy

The four biggest southern European economies have outgrown Germany by about 5 per cent since 2017, underlining the region’s two-speed recovery from recent shocks.

Italy, Spain, Portugal and Greece have collectively added more than €200bn of gross domestic product — more than the entire Portuguese economy — in price-adjusted terms over the past six years, while Germany’s GDP has expanded by only €85bn, according to an analysis conducted by the Capital Economics consultancy for the Financial Times.

Germany’s economy has barely grown since the coronavirus pandemic struck in 2020 after a sharp slowdown in its vast manufacturing sector was exacerbated by a rise in energy prices since Russia’s invasion of Ukraine.

In contrast, southern European countries have been boosted by a rebound in tourism following the lifting of pandemic restrictions, as well as their lower exposure to the manufacturing downturn and loss of cheap Russian gas.

Andrew Kenningham, chief European economist at Capital Economics, said the output of southern Europe’s four biggest countries was “now more than 5 per cent bigger” than Germany’s.

But the growth spurt since 2017 had only partially reversed the ground they lost since the 2008 financial crisis, after which many economies in the eurozone “periphery” suffered banking crises and needed debt bailouts.

“The ‘peripherals’ were 20 per cent bigger [than Germany] before the global financial crisis,” Kenningham added.

The relative outperformance of southern countries seems to have helped the European Central Bank maintain a broad consensus on the timing of potential interest rate cuts, he said, with most rate-setters signalling this is likely to start in June if price pressures keep falling.

“Unlike during much of the last decade, the southern economies are not obviously in need of looser monetary policy than the core,” said Kenningham. “If anything, the opposite may be true.”

The two-speed eurozone economy has also helped narrow the gap between what it costs southern European countries to borrow compared to Germany. The spread between 10-year bond yields in Italy and Germany — a closely watched gauge of financial stress — recently sank to its lowest level since 2021.

Southern countries including Italy and Spain, the eurozone’s third and fourth biggest economies respectively, are expected to continue outperforming this year, as they keep growing solidly while Germany and other northern economies such as Austria and the Netherlands remain stuck in a rut.

Kenningham said he expected the quartet collectively to expand 1 per cent more than Germany between the end of this year and 2026. But he and other economists doubt that the trend will continue much beyond that point.

A recent study by Dutch bank ING found that Austria, Belgium, France and the Netherlands had lost labour cost competitiveness due to rapid wage growth in the past four years, while this had improved in Italy, Spain, Greece and Ireland as a result of productivity improvements. German labour competitiveness was flat.

Another factor is the EU’s €800bn recovery fund, whose mix of grants and cheap loans in return for growth-enhancing structural reforms has predominantly benefited southern countries. Italy and Spain are the first and second-largest beneficiaries of the fund.

Rafael Domenech, chief economist at Spanish bank BBVA, said Spain’s growth had been increased by high immigration that boosted its labour force by 1.1 per cent last year. But he warned: “Given Spain’s low investment per working-age population and [an expected decline in] productivity growth, I doubt that this growth differential could continue in the future.”

Germany’s five leading economic research institutes last week slashed their country’s 2024 growth forecasts from 1.3 per cent to 0.1 per cent. But they forecast growth would recover to 1.4 per cent next year.

Yannis Stournaras, head of Greece’s central bank, told the FT that much of the southern countries’ recent outperformance was due to “Germany’s adjustment of its business model to the new realities” of more expensive energy and lower exports to China, but he added: “I don’t think this is permanent”.

Another factor weighing on German growth has been a sharp tightening of fiscal policy to reduce the government’s budget deficit close to 2 per cent last year to comply with the return of the country’s restrictive debt brake rule.

In contrast, southern countries have maintained a more supportive fiscal stance, with Italy’s budget deficit rising to 7.2 per cent last year.

Italy plans to rein in spending to meet recently restored EU fiscal rules, meaning its outperformance is expected to fade. Kenningham said nearly all of Italy’s growth since 2019 stemmed from the costly “superbonus” tax incentives that boosted private construction, but the scaling back of the scheme made such expansion “unsustainable”.

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