GDP growth offsets EU stagflation fears for now

Can the EU avoid stagflation? That is one of the big questions facing the bloc as the European Central Bank (ECB) nears the apparent end of its current bout of interest rate hikes.

The ECB started raising rates to combat inflation, and while price increases have slowed, they remain stubbornly high. The most recent report from Eurostat, the EU statistics agency, shows core inflation, which strips out volatile items like food and energy, remained stubbornly high last month. That reading of 5.5 per cent copper-fastened the ECB’s decision to increase rates again on Thursday.

So while there are broad signs of an economic slowdown across the continent, there are few signs of inflation reverting back to the ECB’s target of 2 per cent. True, Irish prices have come in below the EU average in recent months, but we will get a better idea of where things stand overall with the flash July inflation data from Eurostat next week.

The danger for the EU is that the interest rate increases kill off economic growth and push up unemployment but don’t actually get inflation down; also known as stagflation. That is a scenario that Japan grappled with for much of the 1990s, and is potentially a real issue for the bloc. The continent’s economy contracted in the first three months of this year, and Germany – its main engine for growth – is seen contracting 0.3 per cent in 2023, according to the IMF.

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It’s that background that makes France’s unexpectedly strong GDP reading on Friday so important. The French economy expanded 0.5 per cent between April and June – well above the 0.1 per cent economists had been forecasting.

That, combined with Ireland’s own 3.3 per cent growth estimate, makes recession in the EU less of a possibility, at least for now.

Economists often say the cure for high inflation is high inflation – ie, that high prices become unaffordable and so people cut back (demand destruction in economist jargon), and the economy slows until prices fall.

So far, that hasn’t really played out in the EU though – retail sales remain stable.

The ECB will make its next call on rates in September. As it gets near the end of the line for increasing, each meeting will become ever more fraught, with stagflation one of the biggest worries.