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Despite ongoing uncertainties surrounding the Middle East conflict and its potential consequences, the eurozone economy expanded more than anticipated in the second quarter, regaining some momentum. The European statistics office reported on Thursday that the gross domestic product (GDP) of the 21-nation currency bloc grew by 0.4% in the three months ending June, compared to the previous quarter. This marks a significant improvement from the zero growth recorded in the first quarter and exceeds the 0.2% expansion forecast by economists surveyed by media outlets. On an annualized basis, the economy grew by 1.8%.
Despite persistent supply chain disruptions and rising energy prices triggered by the conflict between the US and Israel against Iran, eurozone economies have proven more resilient than many economists feared earlier this year when the war first erupted. This energy crisis represents the latest setback for the eurozone, which has struggled to build growth momentum in recent years. Repeated economic shocks, from Russia's invasion of Ukraine to US President Donald Trump's tariff hikes, have pushed business sentiment and activity to historic lows.
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Andrew Kenningham, chief Europe economist at Capital Economics, noted, "The eurozone economy continued to grow steadily in the second quarter, indicating that households and businesses have not significantly cut spending due to the Iran war." In June, inflation eased as an initial US-Iran ceasefire pushed energy prices lower, supporting domestic demand. Meanwhile, manufacturing activity showed resilience to volatility throughout the quarter. Growth was also bolstered by a rebound in the notoriously volatile Irish economy, which expanded by 3.9% quarter-on-quarter after contracting by 7% in the previous three months.
European Central Bank President Christine Lagarde stated last week that digital services performed particularly strongly in the quarter, "partly attributable to the increasing contribution of artificial intelligence-related activities." In the three months ending June, the German economy grew by 0.2% quarter-on-quarter, following a revised 0.4% expansion in the first quarter. The French economy also grew by 0.2%, rebounding from a 0.1% contraction in the previous quarter, while Spain's economy expanded by 0.7%, up from 0.6% in the prior quarter.
Carsten Brzeski, an economist at ING, said that in Germany, some industrial sectors continue to benefit from Asian competitors being more severely impacted by Middle East disruptions. Supported by a booming tourism industry, robust investment, and solid employment growth partly driven by higher immigration, Spain's economy continues to outperform the broader eurozone.
Nevertheless, eurozone growth remains fragile. Although Middle East tensions eased in June, the breakdown of negotiations and further attacks this month could weigh on the economy later in the year. The economy also faces a significant drag from wildfires as record heatwaves continue to sweep across Europe. French Finance Minister Roland Lescure this week described the fires as an "economic thunderbolt."
Daniel Parker, senior economist at Oxford Economics, said, "The wildfires affecting parts of southern Europe are a stark reminder that climate change is reshaping economic and environmental risks... their impact is increasingly being transmitted to the economy through production disruptions, tourism flows, transport, and supply chain bottlenecks."
The European Central Bank last month lowered its growth forecasts for this year and next due to the impact of the Middle East war on real incomes and confidence. The stronger-than-expected growth in the second quarter suggests the economy may be performing better than the central bank feared, although the ECB warned last week that growth could weaken and inflation could rise if the conflict persists.
The ECB last week voted unanimously to keep interest rates at 2.25%, following a rate hike in June. While the central bank has acted faster than the Federal Reserve or the Bank of England in curbing inflation, it has so far noted little evidence of second-round price effects from the energy crisis. On Wednesday, the ECB's wage tracker continued to expect wage growth to slow this year, due to weak recent momentum, low confidence, and high uncertainty.
Although most investors expect the ECB to raise rates for a second time since the conflict began at its September policy meeting, economists warn that further tightening of monetary policy could pressure the already fragile economic outlook. Beyond rising energy prices, the eurozone also faces the threat of renewed US tariff increases. However, Capital Economics' Kenningham suggested that growth could still follow a resilient path. He said, "Looking ahead, we expect the eurozone to continue weathering the Iran energy shock relatively well and forecast GDP growth of around 0.25% per quarter over the next year or so."
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