Europe Skirts a Winter Slump, but War Fallout Clouds Its Economic Future

Despite the shocks of war and inflation, Europe’s economy has shown surprising resilience. Gross domestic product in the euro currency area increased by 1.7% in the first three quarters of this year, compared with just 0.2% growth recorded in the U.S. in the same period. That partly reflects a rebound in tourism in Southern Europe this year, helped by the return of big-spending American tourists, as Covid-19 restrictions eased.

A period of contraction has likely begun. A survey of purchasing managers by S&P Global has recorded declines in activity in each of the final three months of the year, but the December fall was the smallest. A survey of German businesses also pointed to a rebound in confidence as the year draws to a close, as did a survey of eurozone consumers.

“We can look to the new year with significantly less pessimism than we expected in late summer,” said Guido Baldi, an economist at the German Institute for Economic Research in Berlin.

The war’s fallout is reshaping Europe’s relationships with its biggest trading partners, the U.S. and China.

The U.S. economy is currently growing solidly, at roughly a 3% annualized rate according to the Federal Reserve Bank of Atlanta. Its businesses are hungry for advanced engineering goods and machinery produced in Europe as the country builds entire new energy networks.

Meanwhile, China’s bumpy exit from Covid, its increasingly authoritarian leadership and its deepening ties with Russia are encouraging some European companies to seek out alternative markets and sources of supply.

The European Union’s goods exports to the U.S. grew by almost 30% in the first nine months of this year, compared with just 3% growth in exports to China, according to the EU’s statistics agency. That helped the U.S. to surpass China as the bloc’s biggest trading partner for goods. The U.S. is also an increasingly important supplier of raw materials to Europe, notably liquefied natural gas.

At

Amplifon

SpA, a Milan-based hearing-aid retailer with about 2 billion euros in annual revenue (equivalent to about $2.12 billion), sales in the U.S. drove growth this year, according to Chief Executive

Enrico Vita.

U.S. revenue increased by about a quarter in the first nine months of this year compared with 12% for the company as a whole.

Amplifon has increased the number of stores it operates directly in the U.S. from 50 to 300 over the past three years, partly through acquisitions, and is planning further investments there. “The U.S. is definitely a priority for us,” while China is a “medium to long-term project,” Mr. Vita said.

The eurozone’s economy is likely to enter recession this winter, defined as two straight quarters of contraction, but to grow by 0.5% for 2023 as a whole, according to economists at

J.P. Morgan.

The U.S. economy is expected to grow continuously through the third quarter of next year, and by 1% for 2023 as a whole, driven by household consumption and business investment, according to the forecasts. China’s economy is likely to grow by 4.3% next year, J.P. Morgan said, although it also warned of a difficult period as Covid spreads widely following the relaxation of China’s stringent pandemic controls.

Europe’s relative resilience to a historic energy crisis partly reflects government largess. Countries in the euro currency area have budgeted about €600 billion to help households with their energy bills, according to Bruegel, a Brussels-based research institute. Government spending is helping to support growth in the eurozone this year but not in the U.S., according to J.P. Morgan.

The government aid will only provide temporary relief, however. Rising borrowing costs are putting pressure on highly indebted European governments such as Italy’s to trim deficits and are expected to weigh on business spending and investment too. Eurozone inflation, at 10.1% in November, is eroding the purchasing power of workers, whose pay is rising by less than 3% year-over-year according to the EU’s statistics agency.

Natural-gas prices in Europe are expected to remain roughly seven times higher than in the U.S. through early 2024, and two or three times as high through the end of the decade, according to estimates by the German Council of Economic Experts, which advises the German government.

The European Central Bank signaled this month that it will continue to increase its key interest rate, currently set at 2%, for several months to combat inflation that is expected to prove stickier in Europe than the U.S.

For European industry, how energy prices develop in the next few months will be critical, business executives say. Small businesses in some sectors are struggling to cope with high energy prices, while many larger businesses will soon feel the effect after being insulated until now by hedges or long-term contracts, trade groups say.

In Germany, nearly one in four chemical companies has relocated some production overseas or plans to do so, while 40% have reduced production or intend to, according to the German Chemicals Industry Association, a sector that employs roughly half a million people in Europe’s largest economy.

The dislocation in the chemicals sector is starting to limit Germany’s entire industrial supply chain, as supplies of crucial products run short, including pigments, carbon and glass fibers, hydrochloric acid, caustic soda, organic silicone compounds and iron chloride.

Across Germany, factories that use a lot of energy reduced production by about 13% in October compared with the same month a year earlier, although total German industrial output was flat on the year, according to Germany’s federal statistics agency.

“There are many disadvantages [to doing business] in Germany,” said Toralf Haag, CEO of Voith Group, a mechanical-engineering company based in southern Germany with almost €5 billion of annual revenue. Besides high energy costs, Mr. Haag listed high taxes, significant new regulations including around supply chains and insufficient support for research and development.

Voith plans to make around one-third of its future investments in the U.S., currently the source of about 20%-25% of its revenue, Mr. Haag said. China is also an important market, but Voith expects to see more sales growth in the U.S., Southeast Asia and Africa, he said.

Across the EU, foreign direct investment declined by about two-thirds between 2019 and 2021, while total global FDI increased by 11% over the period, according to EU data.

“We see a lot of evidence of businesses using the capacity they have in other parts of the world and considering reinvestments” overseas rather than in Europe, said Fredrik Persson, president of the Confederation of European Business, a Brussels-based trade group representing companies across the continent.

“The U.S. is energy independent, that is something that I think companies are putting into the equation,” Mr. Persson said.

Kempower Oyj,

a Finland-based manufacturer of fast chargers for electric vehicles, plans to invest heavily in the U.S. to take advantage of the renewable energy boom, said CEO Tomi Ristimäki. While the U.S. currently has fewer electric cars than Europe, new subsidies under the Inflation Reduction Act could change that, Mr. Ristimäki said. He expects the U.S. to become a similar-sized market for his company as Europe.

Write to Tom Fairless at tom.fairless@wsj.com and Paul Hannon at paul.hannon@wsj.com