Since 2017, the largest economies in Southern Europe have surpassed Germany by approximately 5%, highlighting the region’s divergent recovery from recent economic challenges. Analysis from Capital Economics for the Financial Times reveals that Italy, Spain, Portugal, and Greece collectively added over €200 billion to their gross domestic product (GDP) in real terms over the past six years, surpassing the entire Portuguese economy. Meanwhile, Germany’s GDP expanded by only €85 billion during the same period. The sluggish growth in Germany can be attributed to the impact of the coronavirus pandemic since 2020, exacerbated by a downturn in its significant manufacturing sector and energy price hikes following Russia’s invasion of Ukraine.

In contrast, Southern European nations have experienced a resurgence in tourism post-pandemic, coupled with lesser exposure to manufacturing declines and reduced dependency on cheap Russian gas. Andrew Kenningham, Chief European Economist at Capital Economics, notes that the combined output of the four largest Southern European countries now exceeds Germany’s by over 5%. However, this growth spurt has only partially recovered ground lost since the 2008 financial crisis, during which many Eurozone economies faced banking crises and required debt bailouts.

Kenningham observes that the outperformance of Southern economies has influenced the European Central Bank’s consensus regarding potential interest rate cuts, with most rate-setters indicating a likelihood of such cuts commencing in June if inflationary pressures continue to decrease. This marks a departure from previous years when Southern economies typically required looser monetary policies compared to their Northern counterparts. This two-speed economy has also contributed to narrowing the bond yield spread between Southern European countries like Italy and Germany.

Southern countries, particularly Italy and Spain, are projected to continue outperforming in the near term while Germany and other Northern economies like Austria and the Netherlands face stagnation. Kenningham forecasts a 1% collective expansion gap between the Southern economies and Germany by 2026. However, there are doubts regarding the sustainability of this trend beyond that point. Recent studies indicate that wage growth has eroded labor cost competitiveness in Northern countries while productivity improvements have benefited Southern counterparts.

The EU’s €800 billion recovery fund, primarily benefiting Southern countries through grants and cheap loans in exchange for structural reforms, has also contributed to their economic resilience. However, concerns linger about the sustainability of this growth trajectory, particularly in Italy, as it plans to rein in spending to adhere to EU fiscal rules. The scaling back of tax incentives for private construction, which drove much of Italy’s growth since 2019, is expected to dampen expansion prospects. Germany’s adjustment to higher energy costs and decreased exports has also impacted its growth, further underlining the transient nature of Southern Europe’s outperformance.