Southern Europe to continue outperforming

• Southern Europe have witnessed strong growth in the previous years while Germany and France have struggled to recover following the pandemic. Southern countries benefit from larger service sector and lower energy price increases.

• We expect southern economies to continue outperforming as they benefit from strong services demand due to rising real incomes and strong labour markets.

• The strong macroeconomic performance has been reflected in upgrades of credit ratings as well as a very solid relative performance in the Spanish, Portuguese and Greek government bond markets. We expect continued outperformance and that the 10Y spread between France and Spain will converge to 0bp (see page 2&3).

Larger service sector and lower energy costs benefits Southern

The Southern European countries have witnessed strong growth in the previous years while the traditional euro growth engines in Germany and France have struggled to recover following the pandemic. In the second quarter of 2024 German real GDP growth was at the same level as in 2019 while Greece and Portugal had managed to grow 8% and 7%. Most recent quarterly growth in 2024H1 has averaged 0.9% q/q in Greece, 0.8% q/q in Spain, and 0.5% q/q in Portugal while German and French growth has averaged 0.1% q/q and 0.2% q/q, respectively.

Southern European countries have benefited from a relatively larger service sector. As the service sector has been the main growth driver post-covid, this has created wedge between the South and the rest of the euro area. In Greece the service sectors accounts for 78% of the economy, in Spain 75% and Portugal 77% respectively compared to 69% in Germany. Manufacturing production in all countries except Greece is below pre-covid levels, and activity has been particularly weak in Germany and Portugal.

Another explanation for the growth divergence is differences in energy price developments. Energy price increases have been more muted in Southern Europe compared to Germany and France as the southern countries have been less reliant on Russian gas due to supply from Africa and relatively more renewable energy sources. Average electricity prices for companies in Germany and France rose by 150% and 140%, respectively, in the period 2022-2023 compared to 2019, while companies in Spain and Portugal only saw a 30% and 90% increase, respectively, in the same period.

While companies in Portugal have witnessed smaller increases in energy prices compared to German competitors, production is still almost as weak. The Portuguese economy has a significantly faster pass-through of monetary policy rates to corporate and household loan rates compared to Germany, which has countered the impact of lower energy prices. In Greece, the economy has both a high pass-through of monetary policy rates and experienced a large increase in energy prices. Despite this, manufacturing production is 25% higher compared to pre-covid thanks to a broad-based increase across sectors. In fact, demand for labour in the industry is so high that the government has allowed companies to extend the working week to 6 days to cope with labour shortages.

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