The U.S. and European Economies Are Diverging

The gap between the U.S. and European economies is widening, with growth and inflation on different trajectories as the fallout from the war in Ukraine weighs on Europe’s prospects.

The European Union’s statistics agency Tuesday said the combined gross domestic product of the eurozone’s 20 members fell by an annualized 0.4% in the three months through September, having increased by 0.6% in the previous quarter.

This is a stark contrast with the 4.9% rate of annualized growth recorded by the U.S. during the same period, more than double the pace of growth in the previous quarter.

Added to this are signs that consumer-price inflation is easing in Europe’s single currency area while it has increased recently in the U.S. Figures also released by Eurostat showed prices were 2.9% higher in October than a year earlier, the lowest rate of inflation since July 2021. The core rate of inflation, which excludes energy and food prices, fell to 4.2% from 4.5% in September.

Economic growth in the eurozone has lagged behind the U.S. since the global financial crisis that struck in 2008, and that gap has widened since the onset of the Covid-19 pandemic in 2020.

This divergence accelerated markedly after Russia’s invasion of Ukraine pushed energy and food prices sharply higher, weakening household spending in the eurozone. As a region that imports most of its energy, Europe has been harder hit by an increase in gas and electricity prices while the U.S., an energy exporter, has benefited to some extent.

And globally, a switch in spending to services from goods and a slump in international trade amid mounting geopolitical tensions hit large manufacturers and exporters such as Germany particularly hard. Eurozone governments have also spent less freely than their U.S. counterparts in supporting demand.

“The German economy is currently stagnating; the obstacles of interest rates, high energy prices and weak foreign demand are simply too great at the moment,” said Geraldine Dany-Knedlik, co-head of economic policy at DIW Berlin, an economic research institute.

The widening growth gap and the narrowing inflation gap between the eurozone and the U.S. suggest that the European Central Bank’s rate rises are having a greater impact on an economy that already faced stronger headwinds.

“Our past interest rate increases continue to be transmitted forcefully into financing conditions,” said ECB President Christine Lagarde in a news conference last week. “This is increasingly dampening demand.”

Some critics of the ECB argue that by almost matching the Federal Reserve’s rate rises while confronting stronger headwinds to growth from other sources, eurozone policy makers will make the growth gap even wider.

“Having fallen behind the U.S. for the past 15 years, my worry is that we may now suffer another widening of the difference in per capita income due to a policy mistake,” wrote Erik F. Nielsen, economic adviser to Italy’s UniCredit Bank, in a note to clients.

Meanwhile, the eurozone’s weakness is holding back other parts of the world economy. The EU’s imports from China in the first eight months of this year were down 15.4% on the same period of 2022, while imports from the U.K. were down 13.7%. Imports from the U.S. were little changed as Europe looked to the world’s largest economy to replace natural gas that it no longer buys from Russia.

In the wake of the invasion, energy and food prices have risen more sharply in Europe than in the U.S. since the invasion, reducing the ability of households to spend on other goods and services.

Households around the world have cut back on their spending on goods after splurging during the Covid-19 pandemic and instead have focused on the services they were denied during lockdowns. But that swing has been particularly pronounced in Europe: By August, retail sales in the eurozone were 7.5% lower than in January 2022, compared with a 1.8% drop in the U.S.

Total consumer spending in Germany was 0.5% lower than a year earlier in the three months through June, while in the U.S. it was 1.8% higher. In the third quarter, U.S. consumer spending surged again, while consumer spending fell in Germany.

The second blow for Germany and the rest of Europe has come through higher costs for energy-intensive factories. Output cuts in Germany’s large chemicals industry, among other sectors, meant industrial production in August was 2.2% lower than the month before Russia’s invasion of its neighbor, while in the U.S. production was up 2.3%.

There are few signs that economic growth in the eurozone is set to pick up over the coming months. October surveys of eurozone businesses released by S&P Global last week pointed to the largest decline in activity since November 2020, with new orders falling sharply and purchasing managers reporting the first reduction in employment since January 2021. By contrast, a similar survey of U.S. businesses pointed to a pickup in activity during October.

With eurozone wages rising at a slightly faster rate, households are beginning to regain some of their lost spending power. While that should aid growth in 2024, parts of Europe face more deep-rooted challenges. Germany in particular is wrestling with whether to keep its energy-intensive chemicals industry on life support for long enough to find new, renewable sources of cheaper energy.

While one member of the three-party coalition government supports energy subsidies, the other two members have reservations.

BASF, Europe’s largest chemicals maker, Tuesday said sales in the first nine months of this year were sharply down on the same period of 2022, and announced that it would cut back on new investments.

“I am not a friend of subsidies, but for a certain period of time, I do believe you should define an electricity price that will be sufficient for industry until we have renewables and then energy-intensive industries will have a chance to survive,” said Martin Brudermüller, BASF’s chief executive.

On top of those headwinds, the ECB has raised its key interest rate to a record high, and to a level that policy makers believe is cooling demand. The central bank Thursday ended a historic run of 10 consecutive rate increases, but said they would continue to weigh on the economy through the first quarter of next year, if not for longer.