Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Europe's Hidden Growth Engine Isnt Germany Anymore
Transcript
- Lucas: So we talk a lot about Germany as the engine of Europe. But if you look at the latest GDP data from early 2026, the engine is sputtering — and a few smaller countries are pulling the Eurozone forward. Luna: You're talking about the divergence in growth rates? I saw the headline: Eurozone real GDP growth hit two percent annualised in the first quarter, up from 0.5 percent a year ago. That's a big jump. Lucas: Right, but the regional breakdown tells a different story. Germany grew at just 0.8 percent annualised. Meanwhile, Spain posted 3.1 percent. Italy 2.5 percent. Portugal around 2.8. The periphery is outperforming the core for the first time in over a decade. Luna: That's a reversal of the post-financial-crisis narrative. What changed? Lucas: A few things. First, the EU recovery fund — those grants and loans are flowing disproportionately to Southern Europe. Italy and Spain are the biggest recipients. That money is being spent on digital infrastructure, green energy, and public investment. It's actually showing up in GDP. Luna: So the NextGenerationEU program is finally having a measurable impact? I remember there was a lot of skepticism early on about whether it would just be bureaucratic bloat. Lucas: There's still some of that. But by mid-2026, you can see real projects on the ground. Spain's high-speed rail expansions, Italy's digital public administration upgrades — these are concrete. And they're creating jobs. Meanwhile, Germany is dealing with the hangover from the energy crisis and the China slowdown. Luna: Germany's manufacturing PMI has been in contraction territory for months. And their export model relies heavily on China, which is still struggling. Lucas: Exactly. The trade-weighted dollar index is at 119.3, which is strong, and the euro has weakened to 1.16 per dollar. That usually helps German exporters, but not when their biggest customer — China — is buying less. Meanwhile, Southern Europe is more services-oriented. Tourism is booming post-pandemic and that's a huge GDP contributor for Spain, Portugal, and Italy. Luna: Tourism alone can't sustain long-term growth though. What about competitiveness? Lucas: That's the real question. If these countries use the recovery fund to upgrade their digital infrastructure and streamline bureaucracy, they might actually close the competitiveness gap with Germany. Early signs are promising. Spain's digital services exports grew 15 percent year-over-year last quarter. That's not just tourism. Luna: So what does this mean for the ECB? They're trying to set one interest rate for a region that's diverging more and more. Lucas: It's a nightmare for them. The ECB wants to keep tightening because core inflation is sticky — services inflation especially. But Germany is screaming for looser policy because its economy is weak. Meanwhile, Spain and Italy are growing just fine and could absorb higher rates. The ECB has to choose who to prioritize. Luna: And historically, they've prioritized the core — Germany, France, the Netherlands. But if the periphery is now the growth engine, do they need to rethink? Lucas: They won't admit it, but the data is forcing their hand. If you look at the European equity markets, the VGK is up 1.5 percent in the last five days, the EZU up 1.9. But the German ETF EWG is only up 1.3 percent. The market is already pricing in this divergence. Luna: So investors are rotating into Southern European exposure? I noticed the Italy ETF EWI is up only 0.3 percent though, so maybe not fully yet. Lucas: That's a good point. The rotation isn't a straight line. But over a longer horizon, the growth differential is starting to attract attention. I think we're at the beginning of a multi-year trend where Southern Europe catches up in terms of productivity and income per capita. Luna: That would be a huge shift. For decades, the narrative has been 'Germany works, Italy doesn't'. If that flips, it changes investment strategies across the continent. Lucas: It also changes the political dynamic. Populism in Italy and Spain has been fueled by economic stagnation. If growth picks up sustainably, that could weaken the appeal of anti eu parties. The ECB's job might actually get easier if the whole region is growing. Luna: But there's a risk too — if the periphery overperforms and Germany stagnates, you could see resentment build in Germany, where taxpayers are still on the hook for EU bailout funds and the recovery fund. Lucas: That's the political tightrope. Germany has already been grumbling about the recovery fund being a transfer union. If their economy stays weak while Southern Europe booms, the calls for reform could get louder. Luna: Speaking of the recovery fund and how it's being used — we do a deep dive on these topics every episode, and we keep the show free of ads because we think that makes the conversation more honest. If you find value in that, you can support the show at buy me a coffee dot com slash fexingo. Just a simple way to keep it going. Lucas: Yeah, it's a small gesture that makes a big difference for us. So back to the data — one number that really stood out to me was real GDP growth in the Eurozone hitting two percent annualised. That's up from 0.5 percent a year ago. But if Germany is growing at 0.8 percent, and the periphery is above 2.5, that math means the periphery is doing the heavy lifting. Luna: How sustainable is that? Can Spain and Italy keep growing at that pace without overheating? Lucas: They have room to run because their starting point was so low. Italy's GDP per capita is still below its 2007 peak. Spain only recovered to pre-pandemic levels last year. So they're playing catch-up. That gives them a longer runway before they hit capacity constraints. Luna: But they also have high public debt. Italy's debt to gdp is around 140 percent. If interest rates stay elevated, that's a drag on growth through higher borrowing costs. Lucas: It is, but the ECB's Transmission Protection Instrument — the TPI — is specifically designed to prevent a bond market crisis for countries like Italy. So the backstop is there. And with the recovery fund providing grants rather than loans, the debt burden isn't growing as fast as it could. Luna: So the policy framework is actually supporting this divergence. That's interesting. For years, the concern was that one-size-fits-all monetary policy would hurt the periphery. Now fiscal policy is offsetting that. Lucas: Exactly. It's a coordinated approach. The ECB keeps rates high enough to fight inflation, but the EU fiscal transfers give the periphery enough oxygen to keep growing. It's not perfect, but it's working better than many expected. Luna: What about the other side — the countries that are not in the Eurozone? The UK, for example, is doing its own thing with trade deals. The uk gulf deal was just announced. Lucas: Right, that's a different dynamic. The UK is striking out on its own. But within the Eurozone, the recovery is increasingly led by the south. And that has implications for the euro exchange rate too. If the periphery grows faster, the euro might strengthen over time as the overall economy improves. Luna: But the euro has weakened recently to 1.16 per dollar. That's partly due to dollar strength — the trade-weighted dollar index is at 119.3 — and partly due to geopolitical uncertainty from the Iran conflict. Lucas: The Iran war is a wild card. It's pushing up energy prices, which hurts Germany more than Spain because Germany is more energy-intensive in manufacturing. So the conflict actually widens the growth divergence. The periphery benefits from lower energy dependence and a tourism boost as travelers avoid the Middle East. Luna: So in a strange way, the Iran war is accelerating the shift we're talking about. Lucas: It's a brutal way to accelerate, but yes. The countries that invested in renewables and services are more resilient. Germany bet on cheap Russian gas and lost. That's a structural disadvantage that will take years to overcome. Luna: What does this mean for someone investing in European stocks right now? Should they be overweight Spain and Italy? Lucas: I think it's worth looking at. The ETFs like EWP for Spain and EWI for Italy have underperformed the broader European indices over the past five days — EWP up 0.1 percent, EWI up 0.3 percent. But over the next 12 to 24 months, if the growth materializes, they could catch up. The key is to watch whether the recovery fund projects actually deliver productivity gains. Luna: And if they don't? If the money is wasted? Lucas: Then you get a debt crisis down the line. But the oversight is better than in the past. The European Commission is monitoring disbursements closely. And the political stakes are high — if the fund fails, the entire EU integration project takes a hit. So I think they'll make it work. Luna: It's a bet on institutional competence. That's not always a safe bet in Europe. Lucas: Fair point. But the data so far is encouraging. GDP growth is up, unemployment is falling in the south, and business confidence is improving. The divergence is real, and it's the most interesting story in European macro right now. Luna: So to sum up: Germany is no longer the undisputed engine. The south is rising. The ECB has to navigate a divided economy. And investors should pay attention to where growth is actually happening. Lucas: That's the takeaway. And if you want to keep following this story with us, we'll be tracking it every week. Thanks for listening.