Europe’s economy grows after months of stagnation, but rate hikes weigh on businesses

Europe’s economy has grown modestly after months of stagnation, but higher interest rates designed to fight inflation are casting a shadow as they make it more expensive for households and businesses to borrow, invest and spend.

The 20 countries that use the euro currency and their 346 million people saw 0.3% growth in the April-to-June period, compared with the first three months of the year, the EU statistics agency Eurostat reported Monday.

That’s an improvement over zero growth in the first quarter and a slight decline in the fourth quarter of last year — but not by much. Plus, one-time factors and an outsized bump from Ireland made things look better than they really were.

The eurozone got a boost by 0.5% growth in France and 0.4% in Spain, where lower inflation has helped lift consumer spending power.

Yet the French figure was increased by the delivery of one very large manufactured item — a cruise ship. That statistical quirk flattered French growth but does little to disguise weak demand for goods in the eurozone’s second-largest economy.

Ireland’s growth of 3.3%, largest in the eurozone, also distorted the overall picture. Its growth figures often show large swings due to major international companies housing their headquarters there, including tech giants like Meta, Google and Apple.

Without Ireland, euro-area growth would have been only 0.1%, said Franziska Palmas, senior Europe economist at Capital Economics.

The overall figure “was driven by a few country idiosyncrasies and masks an underlying momentum that is likely much closer to stagnation,” said Marc de Muizon, senior European analyst at Deutsche Bank Research.

Europe’s largest economy, Germany, struggled in the second quarter, recording zero growth after two straight quarters of falling output as it grappled with high energy costs tied to Russia’s war in Ukraine. Italy, the No. 3 economy, shrank by 0.3%.

The eurozone growth figures for the first quarter were revised from a decline of 0.1%, statistically erasing what had been two straight quarters of contraction — one definition of recession.

Inflation in the eurozone, meanwhile, continued its gradual decline, falling to 5.3% in July from 5.5% in June.

Europe is still struggling with the aftershocks of Russia’s invasion of Ukraine, including Moscow cutting off most of its natural gas to the continent that sharply raised prices for the fuel and the electricity it generates.

In Germany, Europe’s manufacturing powerhouse, Vice Chancellor and Economy Minister Robert Habeck has proposed capping energy prices for industry with government help.

The worst of the price spike is over, but costs are still higher than before the war began. Energy has faded as a main driver of inflation, but price rises are hitting Europeans when they shop for groceries, clothes and more, and the rebound for services companies — such as hotels and restaurants that suffered during the Covid-19 pandemic — has mostly run its course.

Food prices rose 10.8% in July from a year earlier, an improvement from June and previous months but still a pain point for households. Energy, meanwhile, kept dropping, falling 6.1%. Stripping out volatile food and energy prices, core inflation held steady at 5.5% — a key indicator that has not fallen as much as central bankers want.

In a bright spot for Europe, rebounding travel, especially in the Mediterranean countries that heavily rely on tourism, is expected to support growth in the upcoming third quarter as people flock to the beach for their summer holidays in Greece, Spain and Italy, despite recent heat waves and wildfires.

Other than that, prospects for the rest of the year are muted. Another drag on the economy is the rapid series of interest rate increases that the European Central Bank has unleashed to knock down inflation.

The ECB made its ninth straight hike Thursday, bringing its key deposit rate from minus 0.5% to 3.75% in just one year, a record pace since the creation of the euro in 1999. The result has been higher mortgage rates and canceled construction plans due to expensive or unavailable credit.

The central bank’s lending survey shows the lowest level of business loans and credit lines since the statistics started in 2003.

Bank President Christine Lagarde left open whether the bank will keep hiking rates at its next meeting on Sept. 14, saying the decision will depend on incoming inflation data.

Since the rate hikes began, inflation has steadily fallen from a peak of 10.6% in October, but July’s figure of 5.3% is still well above the ECB’s 2% target.

Bank officials say tough action now will spare even more painful restriction of credit later if inflation gets completely out of control.