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The Macro Brief – Europe on a mission
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Simon Wells, Chief European Economist, assesses the growth outlook for the region and the contrasting fortunes of the ECB and Bank of England in their bid to tame inflation.
Disclaimer: https://www.research.hsbc.com/R/101/nFbhDKS
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Transcript
Podcast Introduction
00:00:01
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
European Economies: Eurozone vs UK Challenges
00:00:24
Speaker
You're listening to The Macrobrief, the podcast that looks at the issues driving financial markets across the globe. This episode was recorded for publication on the 2nd of October 2025 by HSBC Global Investment Research.
00:00:35
Speaker
All the disclosures and disclaimers associated with it must be viewed on the link attached to your media player. And remember to like and subscribe to The Macrobrief wherever you get your podcasts.
Eurozone Inflation Management by ECB
00:00:54
Speaker
Hello, I'm P.S. Bartle in London and welcome to the Macrobrief. This week we're focusing on Europe and a tale of two economies. On the one hand, the ECB has kept Eurozone inflation close to its target, growth is resilient, and increased spending is on the cards across much of the region next year.
00:01:11
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By contrast, in the UK, sticky inflation and potential fiscal tightening look set to make it a difficult autumn for policymakers. So to assess the outlook, I'm joined in the studio by Simon Wells, Chief European Economist.
00:01:24
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Simon, welcome back to The Macrobrief. Thank you. So you've just published your latest quarterly, and in it you say... mission accomplished with reference to how the ECB has basically brought inflation under control and within a whisker of its 2% target.
00:01:39
Speaker
How did they manage that given that other central banks have struggled, notably the Fed and the Bank of England? Well, inflation has come down everywhere, but I think the remarkable thing is ah couple of years ago we had double-digit inflation, and now we're looking, at least in the Eurozone, to be back sustainably to the target at very little economic cost, so no massive rise in unemployment or recession. And quite quickly as well, isn't And very quickly. i mean Which, compared to previous episodes of high inflation, one wouldn't have been led to believe that.
00:02:12
Speaker
That's right. Usually when inflation gets above 10%, it can take decades to bring it back under control. And so you're right, this has happened quickly. um Of course, it reflects the nature of what happened. A lot of it was an energy shock and that has reversed and so inflation comes back
ECB's Inflation Control Strategies Compared
00:02:28
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down. But the difference now versus, say, the nineteen seventy s is that there is still a degree of credibility in the monetary regime.
00:02:39
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Central banks are independent. And that means that when we saw inflation ah rise sharply, there was still a degree of anchoring of expectations. And that's one of the major reasons why the ECB and others have been able to bring inflation um back down ah relatively quickly. And of course, it also makes some of the attacks that we're seeing on independent central banking perhaps all the more alarming.
US Trade Impact on Eurozone Economy
00:03:06
Speaker
Now you say mission accomplished, but ah is it really mission accomplished with all the disruption that we've seen to trade from the US? Isn't that going to hit the Eurozone economy with a lag? I had in mind that that would have an inflationary impact, but as you highlight, the risk of trade diversion could work in the opposite direction. So what's the picture looking like going forward?
00:03:24
Speaker
Well, it's never really mission accomplished, is it? um I think you're right. In the near term, the risks are are to the downside. First of all, particularly in the eurozone, we've seen currency appreciation. Some more of that could be passed through to lower import prices.
00:03:39
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And you mentioned trade diversion. I think there is quite a bit of evidence. What what is trade diversion for? So that's that's some Chinese cargos, Chinese goods that were previously destined for the US, now coming to Europe at discount prices and potentially reducing inflation here.
00:03:57
Speaker
Now, we've we've seen evidence of trade increasing, but so far that hasn't been passed through to prices for whatever reason. so But there is a risk that that just happens with a lag.
00:04:09
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And as for tariffs themselves, well, I think the idea of Europe retaliating in a strong way now, given the deals that have been done, seems unlikely. And therefore, the inflationary impact from a European perspective will be in terms of ah less demand potentially for ah exports into the US. And that could also have a mildly disinflationary impulse.
00:04:29
Speaker
So in the near term, I think the risks are perhaps towards lower inflation. And indeed, we forecast sub-target inflation in in Europe next year. But in the medium term, I think it's a different story. And and that's why you can never fully claim its mission accomplished. Yes. And in fact, in your forecast, you assume that the next move by the ECB on rates could be up.
Future of ECB Rates and Inflation Forecasts
00:04:51
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That's right, Piers. Perhaps not until the back end of 2027. But nevertheless, the next move up is very unlikely in 2026 because inflation ah should be sub target.
00:05:03
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But beyond that. um We've got the potential margin rebuild from firms. We've got high rates of unit labour cost growth in Europe, or still relatively high.
00:05:14
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And that's because wage growth seems to have flattened out at around 4%. And then we've got a range of more structural factors, such as potentially more frequent and severe climate shocks, or reconfiguration of supply chains, all of which might add a little bit of an inflationary uplift.
00:05:33
Speaker
So by the end of 2027, we're forecasting 2.3% inflation and rising, and that might warrant a recalibration of ECB policy. So we pencil in rate rises for September and December 2027. So the picture is very different in the UK, where inflation is proving to be much more stubborn.
00:05:53
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Tell me
UK's Economic Challenges: Wage Growth and Inflation
00:05:54
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why. i'm obviously interested, given I'm suffering living in the yeah UK, and I'm sort of perplexed by by how stubborn it's proving to be. Yeah, that's right. And I think the UK has faced um some one-off issues. For example...
00:06:07
Speaker
Wage growth is already higher in the UK than it was elsewhere. And then there was a bit of a kicker from the tax rises on firms, which added to their labour costs in April. And the way regulated prices rose in April was also pushed up inflation for a year.
00:06:24
Speaker
Good news for you, Peirce, by next April, a lot of these things should be dropping out. So then inflation in the UK should fall ah back quite rapidly. But there's also, again, a structural thing here, which is the sort of recent and long-term history of UK inflation, where it's tended to be higher.
00:06:42
Speaker
And ah that, I think, may affect some people's and some firms' expectations, and that has made the Bank of england England's job harder. And to keep with your terminology, when it comes to government finances, is it mission impossible for the UK government to get their debt under control?
00:06:59
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That's the big headline at the moment,
UK Government's Debt Management Strategies
00:07:01
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isn't it? It's certainly mission very hard. ah Well, on our calculations, um the government could be looking at another 30 billion black hole to fill come the 26th of November budget.
00:07:12
Speaker
That's a large amount to raise when you've sort of pledged not going to raise taxes on working people and you've tried to make some cuts to the welfare budget and your own party has rejected it.
00:07:25
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Nevertheless, I think the UK Chancellor Rachel Reeves will, through a combination of tax rises and probably having another crack at reducing spending, she will meet her rules.
00:07:37
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um The question for the market will be, well, are the policy proposals ah credible? And particularly if any painful decisions are more backloaded into the second half of the forecast, market may question the credibility. I think there's very little doubt that she will hit the targets.
00:07:54
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But yeah, it's ah it's ah it's a very tough job. And the countdown is the budget is being announced when?
Fiscal Policies in Eurozone Economies
00:08:01
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The budget will be on the 26th of November. So despite all the column inches and headlines, we've still got quite a long time to wait. yeah Yeah. um The picture is ah mixed in Europe. Fiscal expansion in Germany, bit of a gridlock in in France where they still haven't passed their budget and they have to before the end of the year. Strong economy in Spain.
00:08:20
Speaker
How do you put all of that together in getting to your Eurozone forecasts? ah Well, it's difficult. But the first of all, we start with Germany. That's the largest economy that we know is going to um ease fiscal policy fairly substantially. So we've got a fiscal expansion worth about 0.75% of GDP for 26 and 27. And of course, if Germany spends more, there are spillovers to other Eurozone economies as well. So it it provides um a bit of an uplift.
00:08:51
Speaker
For Italy and Spain, the fiscal story is ah is a little bit different. um They still will have a fair amount of money coming from the EU's post-COVID recovery fund to spend in 2026. And some of that may even spill over into 2027 as well. So that's supportive um of of fiscal policy.
00:09:11
Speaker
France, of course, is the exception of the large economies. It will have to pencil in some degree of of fiscal tightening. The previous government was targeting a budget deficit of about 4.6% of GDP next year.
00:09:27
Speaker
I think if it's going to pass a budget, which will be difficult, it's going to have to maybe be a little less ambitious than that. So we're forecasting a 5.3% budget deficit for France for next year.
00:09:38
Speaker
But, you know, even passing a budget is going to be difficult. And we can't rule out the possibility of new elections if ah if a budget can't be passed. So, yeah, like the UK, fiscal conditions in France still pretty tough.
00:09:52
Speaker
So what are your forecasts now? Well for Eurozone growth we've got a forecast of 1.2% for this which slows to 1.0% next year before picking up to 1.4% in 2027. That looks like kind down up profile but next year before picking up to one point four in twenty twenty seven that looks like a kind of downup profile but Highly volatile Irish GDP data wreaks havoc with the overall eurozone numbers. So if I was to strip out Ireland, actually growth builds largely as a result of this fiscal stimulus, but also credit conditions having eased thanks to ECB rate cuts.
00:10:25
Speaker
um So really, the underlying picture is still of kind of slow and steadily building growth in Europe, although you wouldn't know that from looking at our headline numbers.
00:10:38
Speaker
and And that's because there was huge Irish export growth a front loaded ah ahead of potential tariffs. That's going to unwind a little bit. But yeah. The bottom line, I think, is that Europe's economies have been pretty resilient to everything that's happened this year.
00:10:53
Speaker
All the indicators are for the moment that that resilience is going to continue. And then longer term, you've still got rising incomes for consumers. You've still got the fiscal stimulus.
00:11:04
Speaker
So, yeah, hopefully growth steadily rises. So what do you see as the biggest risks to those forecasts?
Risks to Eurozone Growth Forecasts
00:11:12
Speaker
I'm sure there are a lot of downside ones, but any upsides?
00:11:15
Speaker
I mean, I was going to mention the US government shutdown, but it's actually happened. Should we worry about that? I think the read-across for Europe is um probably quite small.
00:11:26
Speaker
The economic impact of the shutdown will, of course, depend on how long it lasts. yes um ah The previous shutdown in December 2018 and up to January 2019
00:11:39
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The CBO in the US estimates that that cost the economy about $11 billion. dollars But most of that sort of is recovered, although $3 billion of it was permanently lost. So that gives you the sorts of of orders of of magnitude.
00:11:56
Speaker
And again, the estimates this time are that up to 750,000 jobs could be furloughed through through the shutdown. um But markets so far don't appear too bothered about this.
00:12:07
Speaker
It happens. So, broadly speaking, a resilient economy. Let's not get too depressed when we see a lot of headlines around Europe, um but still quite a lot of uncertainty that we're going to have to contend with going forward.
00:12:19
Speaker
Yeah. I mean, at the end of the day, it's Europe. pit scanf um It's growing. It looks like it's going to continue, but it's not going to be the fastest growing economy in the world. On that note, Simon, thank you very much for joining us.
00:12:30
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Thank you.
Podcast Recommendations and Listener Engagement
00:12:34
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And a few things before we wrap up. Don't forget to check out the latest edition of our sister podcast, Under the Banyan Tree, where hosts Fred Newman and Harold van der Linde put Asian markets and economics into context.
00:12:46
Speaker
This week, they chat through what's driving commodity prices with guest Paul Bloxham. A reminder that the HSBC Global Investment Research app is available to our clients. It features all of our latest reports, and it can now read out summaries of our key reports with its listen functionality.
00:13:04
Speaker
Just head to Apple's App Store or Google Play to download it. And finally, if you've got any questions or comments, then please email us at askresearch at hsbc.com.
00:13:18
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So that's it for this week. Thanks to our guest, Simon Wells, and to all of you for listening. Please join us next time here on The Macrobrief.
00:13:47
Speaker
Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.