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By Sylvain Broyer, Ph.D., Chief EMEA Economist, S&P Global Ratings
Calling Europe’s performance through the Middle East shock merely “resilient” almost understates the case. In the spring, economists were braced for something closer to stagflation: weaker growth, higher inflation and another blow to confidence. Instead, the euro area delivered a strong second quarter, with gross domestic product (GDP) expanding by 0.6 percent from the previous quarter—comfortably above most estimates of potential growth.
The headline deserves caution, however. Euro-area data are often noisy, and this quarter is no exception. Activity linked to multinational companies in Ireland appears to have provided a sizeable, and potentially reversible, boost to GDP. Yet even after allowing for that distortion, the forecasting miss—that we share with the consensus of economists—was striking. Europe did far better than expected. The question is why.
Europe did far better than expected. The question is why. The answer has two parts.
The answer has two parts. Some of the resilience is temporary—and therefore slightly misleading—reflecting timing rather than genuine momentum. But there is also a more encouraging explanation: Europe is adapting to a changing global economic order, with business investment finally gathering some pace despite uncertainty on several fronts.
The consumer: Spending through the squeeze—for now
The consumer offers the first clue. Household spending generated a third of second-quarter GDP growth, even as higher petrol prices squeezed real incomes. Unlike during the 2022 energy shock, governments had far less fiscal room to cushion the blow. Confidence slumped; pandemic-era excess savings had run out—and still households kept spending.
A handful of one-off factors may explain this unusual behavior. Early adaptation to summer heatwaves and higher fuel costs probably lifted demand for air-conditioning systems and electric vehicles, particularly where fiscal incentives were available—for instance, in Germany. Strong television sales ahead of the FIFA World Cup—helped by the success of European teams—may also have played a part.
The likelier explanation, however, is timing. The inflation shock arrived abruptly, and history suggests European households can take as long as three quarters to adjust spending fully after an unexpected hit to real income. Consumers may simply have delayed the reckoning by dipping into their savings. This pattern is obvious in the European national accounts.
If so, consumption will likely weaken in the coming months, perhaps into early next year. Rising interest rates add to the pressure by rewarding saving over spending. Food prices might increase because of the drought. High-frequency measures, including retail sales, suggest that a slowdown in consumer spending may already be underway.
Companies: Better prepared than in 2022
European companies have weathered this shock far better than they did the last one. Timing again helps explain part of the strength. Exports to the United States—especially pharmaceuticals and chemicals—appear to have been brought forward in the second quarter, notably from Switzerland, Belgium and the UK, ahead of the US Section 232 of the Trade Expansion Act of 1962 investigation and the threat of higher US tariffs.
The character of the shock matters, too. This time, the price surge was concentrated in oil rather than gas—the reverse of 2022. That difference is crucial. Gas is a vital input for the smaller firms that form the backbone of Europe’s economy. Other industrial commodities shipped through the Strait of Hormuz, including aluminum and chemical inputs such as cyclohexane (a key component in the production of nylon) and a couple of “-ylene” chemical products used in the production of plastics, also became more expensive. Yet European companies have so far managed to pass on much of the increase, including through export prices. The deterioration in Europe’s terms of trade has therefore remained limited, which helps explain why margins, production and exports have held up better than feared.
Relative competitiveness has offered another cushion. The combination of Middle East disruptions and trade tensions has hit Asian producers harder. China and Japan, among others, rely more heavily than Europe on energy and industrial commodities routed through the Strait of Hormuz, while US tariffs have fallen more severely on China than on the European Union (EU). Europe sources roughly 14 percent of its energy imports from the Middle East region, compared to 64 percent for Japan, 44 percent for China and 47 percent for India. The result is a modest and sector-specific advantage for European firms, but still an advantage. The second-quarter rebound in parts of Europe’s chemicals industry is one sign. But the tailwind may be fading. European TTF (Title Transfer Facility) gas prices have risen ahead of winter, clouding the outlook for European competitiveness. The terms-of-trade shock may only now be gathering force.
Business investment: The most promising signal
The most important shift may be in business investment. So far this year, it has grown slightly faster than GDP despite uncertainty over trade, energy and geopolitics, both in the Eurozone and in the UK. This is by no means yet a full-blown capital expenditure (CAPEX) boom; it is better understood as overdue catch-up. Manufacturing-capacity utilization remains below average, though it has edged up from its early-2025 low. Investment still sits four percentage points below its pre-pandemic level, even as GDP stands seven percentage points above. Still, the recent improvement may signal something deeper: European companies are learning to operate in a changed world.
This adjustment is visible in the energy transition, supply-chain restructuring and digitalization. In economic terms, these shifts, viewed through an economist’s lens, are driving higher business investment in nonresidential buildings, ICT equipment and software. Europe benefits more from the global artificial intelligence (AI) boom than is widely recognized. It has a competitive edge in manufacturing several intermediate AI-enabling goods, from photolithography wafer steppers to printed circuit-board assemblies, and remains a net exporter of computer services. Although Europe is not building data centers on the scale of the United States or China, information and communications technology (ICT)-equipment investment has risen sharply this year in Ireland, the United Kingdom and the Netherlands—all FLAPD (Frankfurt, London, Amsterdam, Paris, Dublin) countries. Europe’s construction sector is also benefiting from the global data-center boom. Public demand is reinforcing this momentum: Higher spending on defense and transport infrastructure, particularly since Germany’s fiscal plan took effect late last year, could crowd in further private investment. So far, public investment approved under Germany’s fiscal scheme amounts to about 0.5 percent of German GDP.
Business investment could become a more durable source of resilience. Higher long-term interest rates are an obvious obstacle when financing needs are rising. Yet corporate balance sheets do not appear especially strained. European companies have generally reduced leverage in recent years, leaving them better placed to continue investing.
A constructive outlook, after a near-term pause
Europe’s recent resilience, then, is both less and more than it seems.
Europe’s recent resilience, then, is both less and more than it seems.
Some of the strength is clearly temporary, especially among consumers. Corporate resilience may also weaken, particularly among smaller firms exposed to rising gas prices. The rapid pace of second-quarter growth is therefore unlikely to last.
Even so, the broader picture remains constructive. Europe retains a relative advantage over Asian economies that are more exposed to Middle East disruptions and US-tariff shocks. Its role in the global AI cycle is greater than many assume. And public spending on defense and infrastructure is providing a welcome source of demand.
Europe is not immune. The Middle East shock will continue to bite; interest rates are rising; and the summer drought is emerging as another supply shock that could push food prices higher. A slowdown over the next few quarters looks likely—and may be necessary to bring the economy back into balance. Once that adjustment has run its course, however, growth has a good chance of returning to potential next year. Our forecast puts euro-area growth at 1.1 percent in 2027.
ABOUT THE AUTHOR
Sylvain Broyer, Ph.D., has been the Chief EMEA Economist at S&P Global Ratings since 2018. He was formerly the Head of Economics at Natixis CIB and part of the General Management of its German branch. He serves on several public-sector advisory groups, including the European Securities and Markets Authority’s (ESMA’s) Group of Economic Advisers, and is a Member of the European Central Bank (ECB) Shadow Council.
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