Europe’s economy is growing again after months of stagnation. But interest rate hikes weigh on companies

FRANKFURT, Germany (`) – Europe’s economy has grown moderately after months of stagnation, but higher interest rates 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 and their 346 million people saw growth of 0.3% in the April-June period compared to the first three months of the year, EU statistics agency Eurostat reported on Monday.

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

The euro zone received a boost in growth, up 0.5% in France and 0.4% in Spain, where lower inflation has helped boost consumer spending power.

But the French figure was boosted by the delivery of a very large industrial item – a cruise ship. This statistical quirk flattered French growth but does little to hide weak demand for goods in the eurozone’s second largest economy.

Ireland’s 3.3% growth, the highest in the eurozone, also skewed the picture. Growth numbers often fluctuate wildly as large international companies are headquartered there, including tech giants like Meta, Google and Apple.

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

The total “has been driven by some country peculiarities and masks an underlying dynamic 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, posting zero growth after two straight quarters of contracting output as the country grappled with high energy costs related to Russia’s war in Ukraine. Italy, the No. 3 economy, shrank by 0.3%.

Euro-zone growth figures for the first quarter were revised from a 0.1% decline, statistically erasing two straight quarters of contraction – a definition of recession.

Meanwhile, euro-zone inflation continued its gradual decline, falling to 5.3% in July, from 5.5% in June.

Europe is still grappling with the aftermath of Russia’s invasion of Ukraine, including Moscow’s disruption of most natural gas supplies to the continent, sending prices for the fuel and electricity it produces soaring.

In Germany, Europe’s manufacturing powerhouse, Vice-Chancellor and Economics Minister Robert Habeck has proposed government aid to cap energy prices for industry.

The worst of the price spike is over, but the cost is still higher than it was before the war started. Energy has taken a back seat as the main driver of inflation, but price hikes are hitting Europeans when shopping for groceries, clothes and more, and the recovery for service businesses — like hotels and restaurants that have suffered from the COVID-19 pandemic — has mostly halted its course.

Food prices rose 10.8% yoy in July, an improvement on June and previous months but still a concern for households. Meanwhile, energy prices continued to slide, falling 6.1%. Excluding volatile food and energy prices, core inflation has held steady at 5.5% – a key indicator that has not fallen as much as central bankers would like.

As a bright spot for Europe, rebounding travel, particularly in Mediterranean countries that rely heavily on tourism, is expected to support growth in the upcoming third quarter as people head for their summer holidays despite recent events in Greece, Spain and Italy heat waves and forest fires flood the beaches.

Otherwise, the outlook for the rest of the year is subdued. Another drag on the economy is the rapid series of rate hikes launched by the European Central Bank to curb inflation.

The ECB carried out its ninth straight hike on Thursday, raising its key deposit rate from minus 0.5% to 3.75% in just one year, a record pace since the euro was launched in 1999. The result has been higher mortgage rates and overdue construction plans to expensive or unavailable credit.

The central bank’s credit survey shows the lowest levels of corporate loans and lines of credit since statistics began in 2003.

Bank President Christine Lagarde left open whether the bank will raise rates further at its next meeting on September 14, saying the decision would depend on incoming inflation data.

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

Bank officials say tough action now will save an even more painful credit freeze later when inflation spirals wildly out of control.