Inflation Drags Eurozone Economy Into Recession

Contraction in Germany, sharp fall in factory output in Ireland more than offset growth in other economies at start of year.

The eurozone’s economy slipped into recession at the start of the year as high energy and food prices following Russia’s invasion of Ukraine hit household spending.

The European Union’s statistics agency Thursday said the combined gross domestic product of the countries that share the euro fell at an annualized rate of 0.4% during the three months through March, having also declined in the final three months of last year.

Eurostat had previously estimated that the currency area’s economy grew slightly in the first quarter, but sizable changes to data from Germany, Ireland and Finland pushed it into contraction. This left the region with two consecutive quarters of shrinking output, matching the official definition of an economic recession.

Economists expect growth to resume in the three months through June as falling energy bills ease the pressure on household budgets, but any rebound is likely to be anemic. The Organization for Economic Cooperation and Development on Wednesday said it expected the eurozone’s economy to grow 0.9% this year, roughly half as much as the U.S. economy. 

While energy prices have normalized from their 2022 peaks, food prices have continued to rise at a rapid pace, weakening household spending on other goods and services. 

Households and businesses’ borrowing costs have risen as the European Central Bank’s series of rate increases, which started in July last year, have worked their way through the currency area’s financial system. The drag on growth from that source is likely to build over the coming months, with the ECB signaling that it intends to raise its key interest rate for an eighth straight meeting next week. 

“A peak in underlying inflation wouldn’t be sufficient to declare victory: we need to see convincing evidence that inflation returns to our 2% target in a sustained and timely manner,” ECB policy maker Isabel Schnabel said Wednesday. “We aren’t at that point yet.”

The OECD said it expects eurozone inflation to fall to 5.8% this year from 8.4% in 2022, but remain well above the ECB’s target at 3.2% in 2024. 

The change in measured output announced Thursday is small so it may not have a significant influence on the ECB’s interest-rate decisions over the coming months. 

One reason for the eurozone’s slide into recession is that Ireland—long the currency area’s fastest-growing economy—experienced a 44.7% decline in factory output during March, likely driven by U.S. pharmaceutical companies that operate in the country. That led to a 17.3% annualized fall in the country’s GDP during the first quarter.

Ireland’s statistics office hasn’t offered a reason for that drop in production, but figures it released Wednesday showed a rebound of 70.7% in April, suggesting the first-quarter contraction is unlikely to be sustained.   

A more serious worry for policy makers is the fact that Germany, the currency area’s largest member, also entered recession in the first quarter. France, Italy and Spain, the eurozone’s other large economies, all grew. 

The eurozone’s poor economic performance so far this year partly reflects the costs of Moscow’s invasion of Ukraine last year. The Russian economy contracted 2% last year and the OECD expects it to shrink a further 1.5% this year and 0.4% in 2024. Ukraine’s economy shrank by a third in 2022, and is likely to have suffered further damage following the destruction of a dam and hydroelectric plant in the country’s south this week. 

In the U.S., unlike in Europe, a weakening of the jobs market is required before a recession is declared, and that has yet to happen in the eurozone, with employment increasing 0.6% during the first quarter.