Eurozone Posts Marginal Economic Growth in 2Q, But ECB Rate Cut Remains Unlikely — Update

By Joshua Kirby

The eurozone economy grew marginally over the three months through June, figures confirmed Friday, leaving the European Central Bank unlikely to cut its key interest rate next week.

Across the 20 nations that share the euro, gross domestic product was 0.1% higher than the first quarter, in line with previous estimates. That marks a sharp slowdown from the 0.6% expansion recorded over the first three months of the year.

In the eurozone as a whole, falling exports and declining investment acted as a brake on GDP growth over the quarter. But household spending, a key element in ECB decision-making, kept rising, likely adding to the central bank's caution as it considers whether to resume cutting interest rates.

The slowdown was driven by the currency area's largest member, Germany. Output in the export-oriented economy declined by 0.3% as fresh U.S. tariffs hit factory production and confidence among business and households.

Manufacturing orders slumped for a third month straight in July, separate figures from the German statistical authority showed Friday, highlighting the ailing demand clouding the country's factories.

For the first time in a decade, more than 3 million German workers are now unemployed; auto-parts maker Schaeffler last week became the latest major employer to announce job cuts as weak demand forces a downsizing of operations. Luxury-car icon Porsche has meanwhile dropped plans to make its own battery cells, pointing to a slow market for electric vehicles.

Outside of Germany, the eurozone jobs market has held up well and is currently running record low levels of unemployment, offering hope of a rebound in growth. Inflation has meanwhile eased close to policymakers' target, allowing the ECB to cut interest rates faster than its peer central banks in the U.S. and the U.K. lessening the restriction on investment and activity across the currency union. The ECB's deposit rate now stands at 2%.

Still, the slowdown in the eurozone economy underscores the difficulties the continent has faced in recovering from shocks of recent years, notably the energy crisis that followed Russia's full-scale invasion of Ukraine and the need to reduce imports of Russian gas, once a cheap and plentiful fuel for European activity.

Europe's governments and analysts now hope that a planned fiscal drive can inject some juice into the economy.

The European Union and many of its members have pledged to spend more on arms and defense, a fiscal stimulus that economists think could jolt the economy out of its recent rut. In Germany alone, new defense and infrastructure spending could reach as much as 1 trillion euros, or $1.165 trillion, over the coming years.

And while U.S. trade tariffs will weigh on European growth, the deal reached between the two sides over the summer has dispelled some of the uncertainty that left European businesses hamstrung. The agreement will see a 15% baseline tariff applied to European imports in the U.S., higher than previous levies but less of a sting than President Trump had threatened and Brussels had feared.

"The effects [of tariffs] should be more than offset by greater defence and German infrastructure spending over the medium term," Guy Ertz and Stephan Kemper at French bank BNP Paribas wrote in a note after the trade deal was set out.

Hopes for a rebound ahead are among the reasons investors overwhelmingly expect the ECB to stand pat on interest rates for a second straight meeting at next week's convening of the bank's governing council in Frankfurt.

Annual inflation last month inched a little above the 2% level ECB policymakers deem optimal;, and some rate setters are wary of further spikes, noting turbulent global energy markets and domestic pressures from a strong labor market. For the moment, those concerns likely outbalance headwinds from U.S. trade policy.

Indeed, markets are increasingly "looking through" tariff announcements, ECB executive-board member Isabel Schnabel argued at the last meeting in July, according to recently published minutes.

Write to Joshua Kirby at joshua.kirby@wsj.com; @joshualeokirby