The Eurozone economy shows “immunity” to Iran's war! GDP growth in the second quarter far exceeded expectations, and analysts' forecasts for the full year were revised sharply to 0.8%

The Zhitong Finance App learned that against the backdrop of the Iranian war continuing to impact the European energy market, the Eurozone economy handed over an answer that exceeded most people's expectations. According to the latest analyst survey, the economic growth forecast for the 21 Eurozone countries for the full year 2026 has been raised sharply to 0.8% from 0.5% in July. This correction almost entirely reflects the stronger than expected economic performance in the second quarter — GDP grew 0.4% month-on-month for the quarter, double the 0.2% forecast by economists.

More surprisingly, this resilience was achieved in the midst of multiple headwinds — soaring energy prices due to the war in Iran, massive cost cuts and layoffs by European car manufacturers, raging wildfires, and water levels in key waterways such as the Rhine and Danube rivers falling to historic lows. The Eurozone is using data to prove that its “immunity” to geopolitical shocks far exceeds market expectations.

Second quarter “unexpected surprise”: AI investment and consumer confidence are driven by two wheels

According to data released by Eurostat on July 30, Eurozone GDP grew 0.4% month-on-month in the second quarter, and the year-on-year growth accelerated to 1.0%, far exceeding market expectations of 0.5%. This is one of the strongest quarterly increases in the Eurozone since 2023.

The reason behind this performance that exceeded expectations was a combination of three forces of gravity:

First, the wave of AI investment. European companies are following global trends and substantially increasing investment in intangible assets related to artificial intelligence. The ECB specifically stated in its economic communiqué issued on August 5 that corporate investment is shifting from tangible assets to intangible assets such as AI, and “this structural shift may gradually act as a stabilizer of the investment cycle.” The ECB estimates that uncertainty has dragged down Eurozone economic growth by 0.4 percentage points between 2025 and 2026, but the resilience of AI investment is mitigating this drag.

Second, consumer confidence was stronger than expected. Although consumer confidence in the Eurozone plummeted after the outbreak of the war in Iran, it has now picked up somewhat. Household spending performance in the second quarter was far better than Gloomier's forecast.

Third, Germany's fiscal expansion began to gain strength. The government led by German Chancellor Friedrich Mertz has agreed on a comprehensive reform plan aimed at enhancing medium- to long-term economic potential. Germany, France, and Italy all achieved 0.2% month-on-month growth in the second quarter, and Spain continued to lead the Eurozone with 0.7% growth.

July PMI confirmed the recovery momentum: the service sector returned to expansion, Germany broke out of the trough

The strong momentum of the second quarter continued in July. The Eurozone Composite Purchasing Managers' Index (PMI) released by S&P Global on August 5 rose to 52.0 from 50.0 in June, hitting an eight-month high. This is the first time since March that it has returned to the expansion range.

Key details suggest that the recovery is becoming more widespread: the service sector PMI jumped to a five-month high of 51.7, the first expansion since March; Germany recorded its first private sector output increase since March; growth in Italy and Spain accelerated, and Spain recorded the best performance in over a year and a half; employment stabilized in July, ending six months of layoffs; and business confidence rose to a five-month high.

While business confidence picked up, input cost inflation fell to a five-month low, and output price inflation fell to its lowest level since March — this gave the ECB some breathing room between controlling inflation and supporting growth.

Andrew Kenningham, a macroeconomist at KITU, said, “Looking ahead, we believe the Eurozone will continue to better cope with the energy impact caused by the situation in Iran, and we expect the quarterly GDP growth rate to be around 0.25% in the next year or so.” At the same time, he added that if energy prices continue to rise, the economy still faces downside risks, but these risks may be less than generally expected.

Germany: Defense spending becomes an “economic stabilizer”

As the largest economy in the Eurozone, Germany's recovery prospects are particularly critical. According to another survey, the surge in German defense spending will help drive the overall economic growth rate up from 0.8% this year to 1.2% in 2028, up from 0.6% predicted last month.

The government led by German Chancellor Friedrich Mertz agreed on a comprehensive reform plan aimed at enhancing medium- to long-term economic potential. The core of the plan is to amend the “debt brake” clause in the German Constitution to exclude defense spending, thus actually allowing Germany to borrow without restrictions for military purposes. According to the German Ministry of Finance's plan, Germany will borrow more than 800 billion euros by 2030 to break the fiscal constraints that have been maintained for decades. In 2027 alone, the government plans to raise more than 200 billion euros from the market.

The Bundesbank's analysis is more specific: government spending, particularly defense spending, is expected to boost economic growth by a cumulative total of 1.3 percentage points by 2028. The Bundesbank expects a calendar adjusted GDP growth of 0.5% in 2026, 0.8% in 2027, and 1.4% in 2028. The German Ifo Institute maintained its forecast of 0.8% growth in 2026 unchanged.

However, the German economy is still facing significant headwinds. Ifo warned that even if the US and Iran reach a preliminary cease-fire agreement, energy prices are expected to remain high. The government's expansionary fiscal spending is expected to boost economic growth by 0.5 percentage points each in 2026 and 2027, but the drag effect of the energy price shock is expected to reach 0.4 percentage points. Constrained by an aging population and weak productivity growth, Ifo warns that Germany's potential growth rate could fall to only 0.1% by the end of this decade.

Risks Remain: Low Rhine Water Levels and Inflation Rebound

Despite improved growth prospects, the Eurozone economy faces multiple structural risks.

The Rhine shipping crisis is currently the most pressing supply chain threat. As the “European transport artery”, the Rhine carries about 80% of Germany's inland waterway traffic. Due to high temperatures and droughts, the current loading capacity of ships is only about one-third of the normal level. The drop in ship cargo volume has increased the number of ships calling at port by 50 to 60 per cent in recent weeks. This month, the freight price of refined oil products shipped from the German industrial city of Karlsruhe to seaports such as Rotterdam in the Netherlands reached 200 euros per ton, breaking the record high of 130 euros per ton set in August 2022.

On August 5, the water level in the Kaub section of the main thoroughfare of the Rhine broke the record low in history set in 2018. The Rhine is responsible for most of Germany's inland waterway freight, and there are a large number of chemical, steel, oil refining, and energy companies along the coast. The cost of transporting oil from Rotterdam to Karlsruhe via river tankers has soared from around 45 euros per ton at the end of June to 150 to 160 euros per ton. Germany's Kiel Institute for World Economics estimates that low water levels may cause economic losses of 1 billion to 2 billion euros in Germany in the third quarter. British media pointed out that the low water level in the Rhine not only forced some German manufacturing companies to cut production, but may also affect the economic growth prospects of Germany and more European countries this year.

German chemical company Covestro said that restrictions on shipping on the Rhine have affected supply and production in some plants. The company relies on the Rhine for nearly 75% of its raw materials and more than 30% of its chemical products. The Cologne-based chemical company Lanxes described the current situation as “very serious.” Dutch International Group economist Carsten Brzeski warned that the 2018 drought dragged down Germany's economic growth by about 0.3 percentage points, and the economic impact caused by this year's drought may be even worse.

Inflationary pressures also cannot be ignored. Eurozone inflation rose to 2.9% in July from 2.8% in June. A Reuters survey predicts that the ECB will raise interest rates on key deposits in September. The continuation of the Middle East conflict also means that energy prices are likely to soar again. Germany's Ifo has raised the 2026 inflation forecast to 2.9% and 2027 to 2.7%. The ECB expects uncertainty to continue to drag down economic activity for the rest of the year.