By Vaibhav Tandon

As the U.S economy continues to expand at a nice rate of speed, the eurozone is stuck in a pitstop.  Though the common currency region was able to avoid a technical recession last year, preliminary estimates show that activity stagnated in the fourth quarter of 2023.  Incoming surveys and data suggest that the worst is over, but the road ahead is anything but smooth. 

Trade-dependent European economies such as Germany, which are more exposed to the downturn in global manufacturing, have been the main drag on growth.  The eurozone’s largest economy has turned from being a poster child to the worst performing major economy.  Germany’s export-oriented growth model looks to be kaput, amid rising geopolitical tensions and a slowdown in China.  Berlin’s largest trade partner has also emerged as its main competitor, as China dethroned Japan to became the world’s top auto exporter. 

Tight monetary conditions in Europe have contributed to increasing economic divergence with the United States.  Borrowing costs for non-financial corporations and households have surged in the past two years (see below chart).  With banks representing a more important source of credit in Europe than in the U.S., high interest rates have curbed activity much more directly.  By contrast, financial conditions in the U.S. have continued to ease over the past few months, despite elevated policy rates.  

With Europe’s labor markets still tight, wages are rising faster than inflation for the first time in three years, helping consumption to emerge as the main driver of growth. Easing monetary policy in the second half of the year will also help.  The boost to household finances, however, will be partly offset by a restrictive fiscal impulse.

Though the eurozone has weathered a series of shocks and avoided a severe downturn, deep structural problems such as demographics and weakening competitiveness mean that the bloc will likely trail most other major economies not just this year, but likely for years to come.  A slow and steady eurozone economy is losing the recovery race.