Eurozone earnings growth is expected to outstrip the US going forward.

The eurozone economy has outperformed expectations as it grew by 2.2% in Q3, matching the previous quarter. This leaves the level of economic activity just 0.5% below its pre-pandemic peak, meaning that the recovery in GDP should be complete this quarter.

Whilst the eurozone GDP figures surprised to the upside, the results within the major member states were more mixed. France provided the biggest upside surprise, growing by 3% compared to 1.3% growth from Q2. This was thanks to a strong rise in household consumption, which was helped by the further easing of pandemic-related restrictions and an improvement in consumer confidence.

In contrast, Germany disappointed as it grew by 1.8%, down from Q2 growth of 1.9%. Although 1.8% quarterly growth is still high by historic standards, it is clear that supply bottlenecks have hampered the recovery in Germany’s manufacturing sectors. The level of German GDP is still 1.5% below its pre-pandemic peak, compared to France which is just 0.1% below.

A concern for Germany is that it may have missed its chance to take advantage of the strong recovery in global demand for goods. For months, new orders have outpaced output, causing a major backlog, depleted inventories and long delivery times. Companies appear to have responded by raising their prices, though part of this will have also been driven by the higher cost of raw materials.

In the latest data from business surveys, it appears that demand is now fading, reducing the potential upside for German manufacturers. This may be partly due to weakness externally, especially in China and Asia, but it may also be due to a loss in competitiveness, which is more concerning.

Spain saw activity accelerate from 1.1% growth in Q2 to 2% in Q3, but this was below estimates of 2.7%. Though some tourism returned during the quarter, it appears that delays in lifting restrictions may have contributed to the disappointment. Spanish GDP remains 6.6% below its pre-pandemic peak, highlighting the challenge ahead to return to normality.

The Eurozone inflation figures released in the last week of October show headline eurozone inflation reached 4.1% year on year. – the highest rate of inflation since July 2008. Energy inflation reached 23.5%, contributing 2.1 percentage points to the headline rate. This was caused by the recovery in wholesale oil and gas prices which fell sharply last year during the height of the pandemic.

Overall, the latest growth figures are broadly positive and point to an ongoing recovery, particularly in service sectors which were badly impacted by the pandemic. However, there are growing concerns that external demand for goods is fading, especially in response to rising prices which are mostly caused by supply bottlenecks.

Meanwhile, inflation is expected to rise further, potentially denting consumer confidence, and reducing the contribution from household spending, which is expected to be the biggest driver of growth in 2022.
For the European Central Bank (ECB), the message following the October meeting was loud and clear that the governing council sees good progress being made in the recovery, but that there is further to go. The ECB kept all policy unchanged and provided a cautious but optimistic message on the outlook.

The ECB warned of higher inflation on the horizon, but it sees most of the factors driving prices as temporary. The ECB is set to end the portion of its quantitative easing programme related to the pandemic by the end of March next year. But it is expected to keep some other purchases going beyond March and it is clearly not ready to raise interest rates anytime soon.

The potential returns from European equities remains favourable. European markets have been amongst the leaders in this year’s rally. The next few months could see a change in sentiment as economic and earnings momentum switches from the USA to Europe. Eurozone earnings growth is expected to outstrip the US going forward.

Despite the sharp rise in Delta variant transmission readings from across the Eurozone, PMI suggests that business confidence is more resilient than other developed markets.

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