By Vaibhav Tandon

People often raise their spirits by going shopping, also known as retail therapy.  Economists are hoping that Europeans seek out this remedy more often as this year unfolds.

European consumers grew cautious about discretionary spending in 2022, unsettled by the Ukraine war, the loss of purchasing power from inflation and the bite of high interest rates.  Sharp disinflation over the past year fueled expectations that consumption would rebound, but those hopes have yet to be realized.

Labor market resilience has been one of the defining features of European economies in the post-pandemic recovery.  Wages are growing at a solid pace, exceeding the rate of inflation.  Yet households have remained prudent.   

Consumer spending across euro area nations grew just 0.6% last year in real terms (in contrast with 2.2% in the U.S.).  Retail sales were flat in the first quarter, while new car registrations declined from the fourth quarter of 2023.  Retail sales in the U.K. paint a similar picture of stagnation in March, despite the Easter holiday.  Consumer confidence is off its lows, but remains depressed across Europe. 

While European economies returned to growth in the first quarter, the consumption picture was quite mixed at the national level.  Both Germany and Italy are still suffering from weak domestic demand.  Though consumer spending rose in the U.K., the rebound was underwhelming, contributing only 0.1 percentage points to growth.

There are several factors that explain the contrasting behavior of European consumers compared to their American counterparts.  Firstly, the drag produced by tight monetary policy is stronger in Europe than in the U.S.  European mortgages reprice more frequently, raising monthly payments.

Secondly, European countries are engaged in fiscal austerity to a much greater degree than seen in the United States.  As part of these efforts, subsidies to soften the costs of staples are being reduced, challenging household budgets.

Third, higher interest rates and decelerating inflation have made savings more attractive to Europeans.  Eurozone consumers are now earning around 3.5% interest on their deposits.  Savings rates have stabilized above pre-pandemic levels.  Household deposits have more than tripled since mid-2022.

Increasing pessimism around the economic outlook has also prompted caution.  Research shows that rebuilding net worth following the pandemic also contributed to the higher savings rate.     

The two major European central banks are on track to start making policy less restrictive this summer, which will make saving less attractive and may spur more spending.  Lower rates will reduce debt repayment burdens and boost new lending.  According to Oxford Economics, 100 basis points of policy rate cuts in the eurozone will likely reduce household savings by €12 billion and boost real consumption by 0.5%.  

Household spending in Europe is the largest element of expenditure, accounting for a little over half of nominal gross domestic product in the eurozone and about two-thirds in the U.K.  Hence, for a more durable and robust rebound, consumers will have to loosen their purse strings.  That would be just the therapy that European economies need.