Cyclical industries across Europe are in danger from the economic slowdown sweeping Europe, Goldman Sachs warned in a note on February 4.

The polycrisis that has hit the region in recent years has been exacerbated and enhanced by the boomerang effect of extreme sanctions on Russia that resulted, most noticeably, but was not limited to, an energy crisis in 2022.

That has led the de-industrialisation of Germany, which has lost some 10% of its heavy industry and which previously was seen as the “engine of Europe. Now the country is going into its third consecutive year of contraction and the effects of the crisis are spilling out to affect other sectors, The German automotive sector has been the latest victim. Volkswagen has announced it will close or sell three German plants for the first time in its 88-year history, and other car-producing countries are increasingly in danger, says Goldman Sachs.

The investment bank's analysts caution that the imposition of a 10% tariff by the US would be the latest body blow for already battered economies across the Continent and could potentially reduce the region's GDP growth by a full percentage point in 2025.

"Defensive sectors with high margins, such as healthcare, tend to exhibit less volatility amid trade uncertainty," according to the report. "In contrast, automotive and other cyclical sectors are generally the most exposed to rising trade uncertainty. Notably, the Granolas – Europe's largest companies by market capitalisation, including GSK, Roche, ASML, Nestlé, Novartis, Novo Nordisk, L'Oréal, LVMH, AstraZeneca, SAP and Sanofi – have recently underperformed but tend to fare better when concerns over trade policy intensify,” the report said as cited by PAP.

A trade war with the US comes at a very inopportune time, as the EU has already lost its competitive edge versus China and the US, according to the report from former Italian Prime Minister and ex-European Central Bank boss Mario Draghi. Since the release of the report at the end of last year, the European Commission has been scrambling to work out a response to keep Europe in the game, but few concrete measures have been adopted. Draghi called for €800bn of investment a year for the next decade to get Europe back into the game – more money that was spent on reconstruction following WWII – but few of the cash-strapped EU members have this sort of money to hand.  

One of the major complains in the Draghi report is the lack of financial resources available to entrepreneurs in Europe. Any decent start-up that has a chance of scaling usually turns to the deep and liquid US capital markets when it comes to fund raising or an eventual IPO.

This problem was recently highlighted again in a report that found that Poland’s tech sector – one of the more vibrant markets in Europe – is being held back by the meagre access to funding.

"Limited access to investments using capital from venture capital funds remains a structural weakness of the Polish economy," a recent report by economists from the Polish Economic Institute said. "They constitute only 0.01% of GDP (the EU average is 0.05% of GDP). This problem significantly limits the possibilities of financing innovative projects, at the same time pushing away the prospect of reducing the technological gap," it added, PAP reports.

Economic growth in Poland will accelerate to 3.2% or more in 2025, says ING Bank Śląski, making it a European growth champion and bucking the trend, but even this growth will be fettered by Trump tariffs, should they appear. 

"In 2025, growth will accelerate to 3.2% (or higher) from 2.9% in 2024, driven by a recovery in domestic demand. Poland, with its strong internal economic growth drivers, will stand out positively from other countries. The accumulation of savings in 2024 will support continued consumption growth. The second driver of the recovery will be a rebound in public and then private investment," ING wrote in its report.

"The limitation to faster growth is the stagnation in the Eurozone and Germany and the limitations of the supply side of the economy. The factor limiting investment activity is the still high NBP interest rates and the unclear perspective of the beginning of the monetary policy easing cycle," it added.

Energy deals

Among the mooted solutions, the EU is now proposing to restart deliveries of cheap Russian gas via the partially destroyed Nord Stream 1 and 2 pipelines as a way of lowering energy costs and improving Europe’s competitiveness. The peak of the 2022 energy crisis has passed, but energy prices remain twice what they were pre-war and Germany’s energy prices are double the EU average.

The idea is to include a promise to allow Russian gas imports as one of the bargaining chips in mooted negotiations between Kyiv and Moscow expected to begin in the coming months. However, even if this deal goes ahead, it will not be a short-term fix for Europe’s woes, nor help it facilitate the navigation through increasingly uncertain relations with the mercurial Trump.

The cessation of Russian gas supplies coupled with the end of Ukrainian transit gas since January 1 has delivered a double whammy to Slovakia, the EU country that has been worst affected by the monumental remaking of Europe’s energy markets. Russian gas was not only more convenient but also significantly cheaper than any alternatives that Slovakia has access to. Austria, Hungary and Czechia have all also been badly affected, according to Igor Yushkov, an analyst at the National Energy Security Fund and lecturer at the Financial University in Russia.

In addition, Slovakia lost transit revenues, as gas was previously pumped through its territory to Austria. “For a small economy, these transit payments were substantial. Thus Slovakia has simultaneously faced rising gas costs, increasing the production costs of all goods in the country, and a loss of transit income,” Yushkov said in an interview with News.az. The upshot is Slovakia’s economy, like that of Germany, is now less competitive than it was pre-war.

The outlook for Europe’s energy markets this year is for higher prices again as a new energy crisis looms. In 2023, Europe ended the heating season with its underground gas storage tanks 50% full, but this year, thanks to colder weather, the EU is on track to end with only 30% full tanks, which means Europe will have to buy more gas from somewhere to replenish stores ahead of the 2025/2026 heating season. Gas future contracts for the summer are already rising in anticipation and gas prices are currently three-times higher than the long-term pre-war average. Gas tanks in Slovenia and Austria are already close to their technical minimums and both countries are already tapping the reserves of their neighbours. Ukraine’s gas reserves have also fallen to critically low levels by January and will be forced to import an additional 1-2bn cubic metres to make it to the end of winter.

For its part, Russia has never refused to supply gas to Europe and continues to do so via the southern route, TurkStream. Moreover, there is no legal impediment, as Russian gas sales are still unsanctioned as Europe remains hooked on Russian gas. In his first telephone conversation with German Chancellor Olaf Scholz in two years, Putin even offered to restart gas deliveries via Nord Stream, should a ceasefire deal be cut with Ukraine this year.

Trade and tariffs 

"Given our already modest earnings per share (EPS) growth forecasts for Europe, [a trade war with the US] could easily negate any profit increases anticipated for 2025," Goldman Sach said. "We continue to favour certain undervalued defensive areas in Europe that would benefit from declining bond yields, such as telecommunications, renewable energy and real estate."

The trade-related uncertainties are already adversely affecting economic and market outlooks in the Eurozone. "Our economists consistently argue that it's not necessarily the tariffs themselves that matter, but rather the uncertainty surrounding trade policy, which hampers economic growth and investment intentions," the report notes. "In our European data, we already observe some impact on trade. We are below consensus regarding eurozone GDP growth for 2025 and anticipate a 3% EPS growth in Europe, compared to the market consensus of 8%."

While the major foreign policy challenge facing the US is the Russo-China axis, Trump has chosen instead to pick fights with some of the US’ closest and most loyal allies. This week Trump threatened to impose 25% tariffs on all goods imported from Canada and Mexico, although the decision was immediately suspended for a month. Similar tariffs for Europe are mooted.

The EU remains one of the US’ biggest trading partner, accounting for approximately 15% of total US imports, and runs a significant trade surplus that will put it on Trump’s radar. Machinery, equipment, pharmaceuticals and chemicals constitute the largest segments of European exports to the US. These escalating trade risks have emerged following a period of strong growth for Europe pre-Ukraine war; however, in the medium term, the region has not fared as well. Valuations are heavily discounted relative to the US, even after accounting for sector exposures, and positioning in Europe remains low, says Goldman Sachs.

The report also highlights a prevalent pessimism among investors towards Europe. "Conversely, US equities may prove more susceptible to risk if investors view these tariffs as a reason to reassess their assumptions about the risks the US administration is willing to take concerning GDP growth and inflation prospects," the analysts conclude. "In such a scenario, risk premiums could rise more broadly."