News that the euro zone has slipped into recession framed this week’s meeting of the European Central Bank (ECB), where another interest rate increase was announced. Figures last week showed that the euro zone economy contracted marginally in the final quarter of last year and the first quarter of 2023. This meets the definition of a recession, though the figures suggest a period of stagnation, or economic standstill.
In the light of the threats facing the euro zone economy as the Ukraine war sent gas prices surging higher last year, this outcome is a lot better than might have been feared. Europe has weaned itself off Russian energy and, after a spike last summer, gas prices have fallen back sharply. However, euro zone economies are still struggling under the burden of the cost-of-living crisis and higher interest rates.
Eurostat, the EU statistics agency, had previously estimated that the 20-state euro zone economy had expanded slightly in the first quarter of the year. This was revised down after Germany cut its figures and Ireland also revised its GDP estimate downwards. Consumer spending across the zone fell under the weight of the cost-of-living crisis and economists don’t expect much growth over the rest of the year. Despite the news, the ECB decided to increase interest rates at its meeting on Thursday by 0.25 of a percentage point and indicated that something similar is to come at its next meeting in July. That would bring the total increase since last summer to an unprecedented 4.25 percentage points in 12 months, leaving the key marginal lending rate at 4.5 per cent.
Given the long lag before higher interest rates have their full impact on the economy, the ECB risks going too far, too fast. Falling inflationary pressures and slowing growth across the euro zone suggest that the medicine of higher borrowing costs is already having an impact. Fearing that inflation will get embedded in wages and prices across the economy, the ECB insists that there is more to be done. There is a case for it to pause for a period to see how the economic figures develop.