Q4 collapse in domestic demand a bad omen

Recent evidence about the health of the euro-zone economy has been mixed. National figures released so far suggest industrial production rebounded in January but retail sales remained very weak. And while activity surveys now point to a small expansion in GDP in Q1, credit data are consistent with a sharp contraction in output. For our part, we think a recession is still the most likely outcome. One reason for this is that underlying economic dynamics were very weak going into 2023. With consumption and investment both down sharply in Q4, domestic demand experienced its second largest fall outside of the pandemic. And since high inflation is set to keep real household incomes depressed, and the drag from higher interest rates will intensify, we think further falls in domestic demand are likely in the coming quarters.