Broken Europe Broken Europe Broken Europe

Broken Europe

Christopher Dembik

Chef for Macro Analysis

Oversigt:  While the economic situation in Europe may not be as bad as feared, there's still a plethora of things to fix.

A resilient economy

We were too pessimistic about the euro area. Softer energy prices, the lack of black-out (resulting both from energy supply diversification and better weather conditions) and resilient hard data (notably in Germany) are pushing forecasters to review their 2023 recession calls. The eurozone 2023 consensus GDP is up from minus 0.1 percent to 0.0 percent. This is a small but significant move and it doesn’t appear to be the end. We still believe the consensus is too low. In mid-January, Goldman Sachs was the first international bank to completely reverse its call for the eurozone, moving its GDP growth forecast from minus 0.1 percent to 0.6 percent. We are not that bullish at Saxo Bank but we confidently believe that the eurozone could avoid a recession this year with a GDP growth target close to 0.3 to 0.4 percent. Remember that a few months ago, more than 90 percent of the forecasters predicted that a recession is the baseline for this year. 

What has changed? The economy is actually stronger than expected. The Citi Economic Surprise Index (below chart) now stands at a one-year high. This means that economic data are better than economists’ projections. This is especially true for Germany. While gas consumption has collapsed by double digits, industry output has remained largely flat. Not only that this could be considered as a remarkable achievement, based on the latest November data on industrial production, it looks like there will be no recession in German industry in Q4. The first estimate of German 2022 GDP is also significantly higher than forecasted, at 1.9 percent – this represents 0.5 points above the government’s target. Everything indicates that the economy will remain at a resilient pace in the short term, with all the nowcasting models pointing to an economic recovery this quarter. Hence, the probability of a recession is now declining quite fast. We also believe there will be no extreme macro and market events in 2023 – which could be positive from a growth perspective. If the economy performs much better, this will however give ECB policymakers more confidence in hiking rates as laid out in December by Christine Lagarde.

Economic surprises are improving significantly in the euro area. The consensus, 0.0 percent GDP growth in 2023, seems slightly conservative and is bound to be revised up.

But risks are looming

However, this does not mean that the year 2023 will not be challenging:

  • Credit stress is on the rise – this is the first time in a decade we start the year with European IG credit yield above the 4 percent level. Expect many companies to face difficulties getting access to new sources of funding. Many small and medium caps will probably have no other choice but to resort to ultra-dilutive financing, such as convertible bonds. Retail investors should stay away from these listed companies.
  • The market will need to absorb about €700bn of liquidity due to the ECB quantitative tightening. This is a complicated exercise which will result in tighter financial conditions and perhaps higher volatility in equity.
  • The energy crisis will be back on the agenda again. This is not politically correct, but climate change has certainly helped avoid an energy crisis in Europe so far. However, when it will be time to refill depleted stockpiles in the spring, expect that prices will move up again. We are confident that the EU will be able to find energy suppliers (for instance, natural liquified gas from the United States, Australia or even Mozambique), but at a high cost. This will ultimately fuel inflation higher in the second semester, along with higher oil prices resulting from higher Chinese demand (we estimate that China’s reopening will boost oil demand by 4m bpd around spring – this is about three times more than the growth in demand forecasted by the market).
Prices on the wholesale electricity market increased tenfold during the peak of the 2022 crisis in several EU countries. This was partially explained by rising gas prices due to the war in Ukraine and problems with nuclear generation in France. Now, prices are receding. But the market does not expect a return to the pre-Covid situation (where prices were below EUR60 per MWh).

What about the risk of a wage-price spiral?

The labour market remains tight in the eurozone. The last data show that the eurozone unemployment was at 6.5 percent in November 2022 and at 6.0 percent in the European Union. Within the EU, Spain scores the highest official unemployment rate (12.4 percent) and Germany and Poland the lowest one (3.0 percent). In a working paper published in mid-January, ECB economists pointed out the risk of high wage growth in the coming quarters – way above historical patterns: “This reflects robust labour markets that so far have not been substantially affected by the slowing of the economy, increases in national minimum wages and some catch-up between wages and high rates of inflation.” We tend to disagree with this assessment. Wage growth is of course fuelling inflation in the CEE area, but this is clearly not the case in Western Europe. The likelihood that wages will increase significantly, thus becoming an issue in regards to the fight against inflation, is rather low in our view. Actually, in several countries, wage increases are dramatically lagging behind inflation. In Spain, the average real wage is now below what it was 15 years ago! It is hard to think there will be a wage-price spiral. However, if the ECB believes this is a material risk, they could decide to tighten too much – thus increasing credit stress.

Overall, we believe the consensus was and is still too pessimistic about the eurozone 2023 GDP growth. There is a high probability that a recession will be avoided. That being said, Europe is still broken. The energy crisis remains a major risk for the next winter – with the EU being still reluctant to embrace nuclear energy and being unable to move fast on the project of a reform of the electricity market. While the ECB expects wages to increase substantially, we see that workers are in fact becoming poorer in most countries. Several companies which have benefited from the abnormal negative interest rate periods will now face a moment of truth – many of them will probably go bankrupt. Politically, we are not optimistic. EU presidencies offer little ambition – Sweden, which heads the Council of EU unsurprisingly focuses on the Ukraine war while the Spanish presidency in the second half of 2023 will be dominated by elections in the country. There is not much positive to expect from politics this year.


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