News in Charts: It was a (not so) very good year

Euro area GDP has stagnated over the past year, leaving output just 3 per cent higher than its pre-pandemic level. While somewhat better than in the UK, it is a far weaker recovery than seen in the US, where GDP stood nearly 9 per cent above its pre-pandemic level in the third quarter.

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Looking to the GDP components, growth has been fairly subdued across the board. Household consumption has been sluggish at best and investment growth likewise. Government consumption has propped up GDP in recent quarters, and while net exports have provided some support to aggregate GDP, this is mainly due to imports falling faster than exports.

Having seen their real incomes battered by high prices, European consumers have not indulged in any spending sprees. Continued labour market strength and probably some positive real wage growth should support consumption going forward, but consumer confidence remains low compared with historical averages. While the US recovery has in part been driven by consumers drawing down the excess savings they acquired during the pandemic, euro area saving rates indicate consumers are still saving more than they did pre-pandemic.

Work by the ECB suggests that while households initially spent some of the estimated €1 trillion in excess savings they accumulated during the pandemic, they have since 2021 largely placed it in financial assets and to a lesser extent in housing, and in aggregate have not spent these funds. The shift towards less liquid savings has accelerated as interest rates have gone up. The ECB also finds that the bulk of the excess savings is held by households at the top of the income distribution, who generally have a lower marginal propensity to consume.

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Euro area consumer price inflation began to increase rapidly towards the second half of 2021, peaking at above 10 per cent in October 2022. While initially driven by energy price shocks inflationary pressures became more widespread over 2022.  As of November 2023, headline inflation (inflation including energy and food) had come down close to the ECB target of 2 per cent, but core inflation (excluding energy and food) remained closer to 4 per cent. As core inflation rose in part due to the second-round effects of the energy price shock, it is unsurprising that it should start to rise later and similarly take longer to come down. However, this is likely to prove a key sticking point for the ECB’s governing council, and especially for its more hawkish members, who will want to see both inflation measures durably near target before being comfortable in easing rates — provided that no other factors such as a recession come into play.

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The ECB kept rates unchanged at its December meeting and indicated that the terminal rate has probably been reached. Its statement gave no indication of how long rates will remain unchanged. However, we expect to see rate cuts through this year totalling some 200 basis points, as the economy weakens and core inflation continues to fall. That is around twice what is currently priced in.

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The views expressed in this article are the views of the author, not necessarily those of LSEG.

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