Europe’s Economy Edges Higher, Heading Off Forecasts of Recession

Europe’s economy is showing signs it may avoid a recession this winter, even as it continues to cope with persistent inflation, rising interest rates and a war in Ukraine that shows no signs of abating.

On Tuesday, the region’s statistics agency said the eurozone economy grew 0.1 percent in the last quarter of 2022, compared with the previous quarter.

The data came hours after the International Monetary Fund raised its forecast for economic growth in the countries that use the euro to 0.7 percent in 2023, from a prediction of 0.5 percent made in October. The small bump up was because the economy turned out better than expected last year, helped along by lower natural gas prices and government financial support to shield households from some of the rise in energy costs.

“The news has become much more positive in the last few weeks,” Christine Lagarde, the president of the European Central Bank, said earlier this month at the World Economic Forum annual meeting in Davos, Switzerland.

The data and forecasts offer some relief to governments that were planning for power outages and gas rationing as the continent faced winter without Russian gas just a few months ago. Now, overall inflation appears to be at or past its peak and consumers have been surprisingly resilient to the economic turmoil.

“The big picture is less bad than we thought a few months ago,” said Frederik Ducrozet, the head of macroeconomic research at Pictet Wealth Management. The worst risks of a very severe recession or energy rationing have abated, he said.

But this steadying of Europe’s economic picture remains fragile, and not all the predictions are positive.

On Monday, Germany reported that its economy unexpectedly contracted in the fourth quarter, putting Europe’s largest economy at risk of a recession. And the I.M.F. has forecast that Britain’s economy will shrink by 0.6 percent in 2023 as a cost of living crisis erodes spending.

And on Tuesday, France and Spain both reported rising rates of inflation. In Spain, the rate increased unexpectedly after slowing for five consecutive months. Data for the entire eurozone will be released on Wednesday.

“If there is a risk, it’s still the downside,” Mr. Ducrozet said. “Consumers were hit by the largest ever shock to real incomes since the Second World War because of this rise in inflation.”

Still, there are positives to point to. Already this month, the ZEW index of German investor sentiment turned positive for the first time since February 2022, before the war in Ukraine, and a measure of economic activity across the eurozone, the composite purchasing managers’ index, indicated that the economy was growing in January.

Ms. Lagard said the conversation has shifted from expectations of a recession to, in some large economies, a small economic contraction. However, she said the eurozone’s economy would significantly slow in 2023 from the previous year, adding “it’s not a brilliant year but it’s a lot better than we have feared.”

But with the war in Ukraine grinding on, the optimism about Europe’s economy is extremely fragile.

The past year has been a “lesson in humility” when it comes to economic forecasting, said Mr. Ducrozet. He added that, looking at the data so far this year, “it doesn’t look so bad but it doesn’t look good either.”

This seems especially true in Britain, where earlier this month data showed the economy fared better than expected in November, eking out 0.1 percent of growth from the previous month. This means the country will probably avoiding an economic contraction over the fourth quarter, staving off a recession.

But that’s just for the time being. The outlook in Britain is particularly harsh and the I.M.F. downgraded its forecast for the economy, predicting a 0.6 percent decline in 2023, instead of 0.3 percent growth. The economy is expected to be weighed down by the effects of tight fiscal policies and a smaller work force, while higher interest rates increase mortgage costs and steep household energy bills exacerbate a cost-of-living crisis.

“We are expecting a fairly sharp slowdown this year” in Britain, Pierre-Olivier Gourinchas, the chief economist at the I.M.F., said in a news conference. But it follows a better-than-expected economic turnout last year, he added.

Across Britain and the eurozone, one of the biggest risks to the outlook is still inflation. Amid signs that the overall rate has peaked, core inflation, a measure that excludes volatile energy and food prices, remains persistently high. Consumer price gains are expected to continue at a rapid pace well into 2023, and even once they begin a predicted slowdown later in the year, the average household faces lost purchasing power because wages have failed to keep up with inflation.

Meanwhile, the determination of central bankers to return inflation to a target of 2 percent could keep interest rates elevated, imposing higher costs for mortgages and business loans across the continent, restraining the economy.

European policymakers are concerned that the energy shock is still working its way through the economy, while tight labor markets are pushing up wages in a way that they worry is inconsistent with inflation returning to their 2 percent target.

On Thursday, the Bank of England and European Central Bank are expected to raise rates by half a percentage point.

At the Bank of England it would be the 10th consecutive rate increase, lifting the main rate to 3.5 percent, the highest since 2008.

In the eurozone, “inflation by all accounts, however you look at it, is way too high,” Ms. Lagarde said. And so, policymakers will “stay the course,” having already telegraphed that more half-point rate increases were to come.

As January ends, it appears that Europe has escaped the worst-case scenario for a recession through the winter but there is still a huge amount of uncertainty about its outlook. Some of that depends on what happens in the United States, where opinions are divided on whether the Federal Reserve’s efforts to stamp out high inflation will push the economy into a recession, with far-reaching repercussions later this year.

And then there are the uncertain effects of China’s U-turn on its zero-Covid policy. After three years of pandemic lockdowns dampening China’s demand for energy and disrupting manufacturing and international travel, will production pick up to smooth supply chains, and will Chinese tourists quickly spend their savings around the world? Will it cause added inflationary pressure for central bankers to worry about? The answers will come in time.