Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Industrial Production Is Splitting North and South
Transcript
- Lucas: The old story about the Eurozone was that the core—Germany, France, the Netherlands—drove industrial production, while the periphery lagged. That story is flipping, at least for now. Luna: You're looking at the April industrial production data that came out last week? Lucas: Exactly. German factory output fell 0.4 percent month-over-month. Meanwhile, Spain's industrial production rose 1.2 percent. Italy and France were flat to slightly up. This isn't a one-month blip either—the trend has been building for about a year. Luna: That's a sharp reversal from the last decade. What's driving it? Lucas: A few structural forces. First, energy costs. Germany's manufacturing base is heavily dependent on natural gas and electricity-intensive processes. Even after prices came down from the 2022 spike, German industrial electricity prices are still roughly two to three times what they are in Spain or France. That's because France has heavily subsidized nuclear power, and Spain has pushed aggressively into renewables. Germany's Energiewende has been admirable but expensive. Luna: So energy-intensive industries like chemicals, metals, and auto parts are leaving Germany for southern Europe? Lucas: Some are, yes. But it's not just energy. Supply chain reconfiguration post covid and post-Ukraine has favored countries closer to the Mediterranean—shorter shipping routes from Asia, less exposure to Russian gas. Spain and Portugal have also become hubs for data centers and battery gigafactories, partly because of cheaper land and labor. Luna: And then there's fiscal policy. The NextGenerationEU funds are disproportionately flowing to southern Europe. Spain is the biggest beneficiary in absolute terms. Lucas: Right. Brussels has disbursed over 200 billion euros of that recovery fund so far, and a lot of it is going to digitalization and green industrial projects in Italy, Spain, and Greece. Meanwhile, Germany's fiscal policy has been constrained by its constitutional debt brake. The German government is actually cutting spending in real terms this year. Luna: So the north is tightening while the south is investing. That's a recipe for divergence. Lucas: It is. And it shows up in the trade data too. Germany's trade surplus has shrunk from about 8 percent of GDP in 2016 to around 4 percent now. Spain, which used to run a deficit, has a small surplus. The competitiveness gap is narrowing. Luna: If we're talking about competitiveness, we have to bring in the euro. The euro has weakened a bit recently—it's at 1.15 to the dollar, down from 1.16 a few weeks ago. That helps all Eurozone exporters, but it helps the southern countries more because their export baskets are more price-sensitive. Lucas: Good point. A weaker euro lowers the relative price of Spanish olive oil, Italian machinery, French wine. German exporters benefit too, but they compete more on quality and engineering than on price. The trade-weighted dollar index is at 120.1, up a bit, so the dollar is strong broadly. That tailwind for Eurozone exporters is real. Luna: But isn't there a risk that this divergence complicates ECB policy? If Germany is stagnating industrially while Spain is booming, the one-size-fits-all interest rate becomes harder to set. Lucas: Absolutely. The ECB hiked rates aggressively from mid-2022 through late 2023, and they've held them steady since. Those higher rates cool demand—but they cool demand more in economies with variable-rate mortgages and high private debt, like Spain and Italy. So you have this tension: tighter policy hurts the south's consumption but their industrial output is booming anyway because of structural factors. Meanwhile, Germany's industry is struggling but its households are less rate-sensitive because mortgages are mostly fixed. Luna: It's like two different economies inside one currency union. Lucas: Exactly. And that's the old 'core versus periphery' narrative resurfacing, but with the roles partly reversed. The ECB's own economic bulletin last month highlighted this divergence in industrial production as a key risk to their forecast. They're watching it closely. Luna: Speaking of watching closely—I know we don't do ads, but if listeners find this kind of breakdown useful, a lot of them have asked how they can support the show. Honestly, if today's episode was worth a coffee to you, we have a page: buy me a coffee dot com slash fexingo. It's a tiny gesture, but it keeps us independent and ad-free. Lucas: Yeah, we really appreciate that. It makes a difference. Okay, back to the industrial split—let's talk about what this means for the green transition. Luna: Because if southern Europe is becoming the manufacturing hub, they're also inheriting the emissions. Lucas: Exactly. Spain and Portugal are adding solar and wind capacity fast, but they're also building new factories. The net effect on carbon emissions is ambiguous. Germany, by contrast, is deindustrializing in heavy sectors but still has high per capita emissions from transport and buildings. So the geography of pollution is shifting. Luna: And that has implications for the EU's Carbon Border Adjustment Mechanism, the CBAM. If production moves south, the carbon content of imports from outside the EU might change less than policymakers hoped. Lucas: Right. The CBAM is designed to prevent carbon leakage by taxing imports based on their embedded emissions. But if production shifts within the EU, it doesn't change the total emissions—it just moves them from one member state to another. The EU's overall industrial emissions haven't fallen much in the past two years, even as Germany's have dropped. Luna: So the policy needs to target absolute reductions, not just relocation. Lucas: Precisely. And that's where the debate is heading. Some economists argue the EU should couple industrial policy with a stronger carbon price floor to ensure that the shift south doesn't just become a race to the bottom on environmental standards. Luna: Let's zoom out to the macro picture. This divergence—does it change the long-term growth outlook for the Eurozone? Lucas: It might. The Eurozone's real GDP growth has been anemic, around 1.6 percent annualized in the first quarter of 2026, up from 0.5 percent a year ago. But that aggregate masks wide variation. Spain is growing at around 2.5 percent, Germany at maybe 0.5 percent. If the south can sustain its momentum, the overall growth rate could creep up. But if Germany drags on too long, it pulls down the whole bloc. Luna: And Germany is still the largest economy. So it matters a lot. Lucas: It does. And there are structural headwinds for Germany beyond energy: demographic decline, an overhang of auto sector dependence, and the China decoupling. German exports to China have fallen about 10 percent in the last two years as Chinese domestic competitors like BYD eat into market share. Luna: So the north-south split might be a long-term realignment, not just a cyclical phase. Lucas: I think that's right. And it means investors, policymakers, and business leaders need to stop thinking of the Eurozone as a homogenous bloc. The divergence we're seeing in industrial production is a signal of deeper structural shifts—in energy, fiscal policy, demographics, and trade patterns. Luna: One thing I wonder about: how does this affect the euro itself? If the south is outgrowing the north, does that change the currency's equilibrium? Lucas: Interesting question. The euro has been relatively stable around 1.15 to the dollar, but if the growth differential persists, it could put upward pressure on the euro over time. A stronger euro would then hurt the south's export competitiveness more than the north's, potentially self-correcting some of the divergence. But that's a slow-moving process. For now, the ECB is more focused on inflation than on the exchange rate. Luna: Inflation is due out Wednesday. Headline has been sticky around 3 percent. If the south is growing faster, does that mean more inflationary pressure there? Lucas: Potentially. In Spain, services inflation is running above 4 percent because of strong demand. In Germany, it's lower. So the ECB faces a tricky communication challenge: they have to set rates for the average, but the average doesn't describe any single country well. Luna: It's like the doctor treating a patient with a fever in one leg and hypothermia in the other. Lucas: Exactly that. And the prescription—higher for longer rates—might be right for the overall fever but it exacerbates the hypothermia in German industry. That tension is going to be a central theme at the ECB's next meeting in July. Luna: So for our listeners, what's the one thing to watch? Lucas: Watch the German IFO business climate index and the Spanish PMI manufacturing data over the next few months. If the gap widens further, expect more calls for a differentiated fiscal policy—maybe a German stimulus, maybe more eu level transfers. The political conversation is shifting. Luna: And that conversation will shape the Eurozone's next chapter. Lucas: It will. And we'll be here to track it.