Europe Is Growing Again, but the Recovery Is Still Narrow

Executive summary

Europe and the United Kingdom are improving in different ways. Euro-area output rose 0.4% in the second quarter after no growth in the first. Spain expanded 0.7%, while Germany, France and Italy each managed 0.2%. The recovery is real, but not broad.

The UK has not yet published its full second-quarter estimate. Output grew 0.7% in the three months to May and retail sales rose 0.6% across the quarter, but unemployment reached 4.9% and business investment was 1.3% lower than a year earlier.

Inflation is the shared constraint. Euro-area inflation rose to 2.9% in July as energy prices increased. UK inflation eased to 2.6% in June, and regular wages rose 3.4%, giving workers a small real gain. Services inflation of 3.6% shows that domestic price pressure has not disappeared.

The European Central Bank held its deposit rate at 2.25% in July. The Bank of England held Bank Rate at 3.75%, with three members preferring a rise. Credit is expanding more clearly in the euro area; small businesses and property remain constrained.

What this means to investors

Support is moving toward cash-generating, lower-priced companies. MSCI Europe Value returned 4.32% in July, the UK gained 3.87%, and European technology fell 13.48%. This is price performance, not proof of new investment flows.

Banks gain when loan volumes rise without bad debts following. Euro-area business lending grew 4.0% from a year earlier, although banks tightened standards moderately. UK mortgage borrowing jumped in June, but approvals stayed below their six-month average and lenders reported weaker small-business demand. The credit cycle is improving, not booming.

Government debt remains a dividing line. Euro-area debt was 88.9% of output, with France and Italy carrying heavier burdens than Germany. UK borrowing improved, yet financing needs and gilt sales still affect mortgages and rate-sensitive shares.

For Kenya, one euro bought about KSh149 and one pound KSh174 on 6 August. Stronger European currencies lift the shilling value of exports and remittances, but make European machinery, medicines, education and travel more expensive.

Market at a glance

Direction compares with the immediately preceding published period or decision. GDP figures are real and seasonally adjusted.

WHAT THIS TELLS US Europe has moved out of stagnation and UK inflation is easing, but neither region has a clean combination of broad growth and low inflation. Central banks still have reason to wait.

Europe returned to growth, but the largest economies lagged

Euro-area GDP rose 0.4% after a flat first quarter. Spain's 0.7% gain was the clearest sign of domestic strength. Germany grew 0.2%, helped by exports, while consumption stayed cautious and investment fell. France and Italy also grew 0.2%.

The result lowers recession risk without confirming a powerful cycle. June retail trade fell 0.3% from May, and May industrial production was 1.2% below a year earlier. Services and southern Europe lead manufacturing.

Sources: Eurostat; Germany; France; Italy; Spain.

Figure 1. Preliminary Q2 2026 real GDP growth.

WHAT THIS TELLS US Spain is expanding at a useful pace. The euro area's three largest economies are moving forward only slowly, so the recovery remains vulnerable to energy costs, trade weakness or renewed fiscal stress.

Sources: Eurostat; National statistics agencies.

The UK consumer improved before the corporate sector

UK output rose 0.1% in May and 0.7% over three months. Services expanded 0.7% over that period, while construction fell 1.4%. June retail sales rose 1.0% and were 0.6% higher across the second quarter. Consumers are spending, but the economy remains service-heavy.

Regular pay rose 3.4%, slightly faster than prices. The counterweight is 4.9% unemployment and 71,000 fewer payrolled employees than a year earlier. Business investment rose 0.9% in the first quarter but stayed 1.3% below its year-earlier level.

Sources: UK GDP; Retail sales; Labour market; Pay; Business investment.

Europe versus the UK

WHAT THIS TELLS US The euro area has the better published growth acceleration. The UK has the better household inflation-and-pay mix. Both still depend on services and remain exposed to expensive energy and credit.

Inflation: lower is not the same as solved

Euro-area inflation edged up to 2.9% in July. Energy prices were 10.0% higher than a year earlier, while services inflation was 3.3%. Goods inflation remained subdued. This is mainly a supply-cost problem, but it can spread if firms pass energy costs into wages and services.

UK inflation eased to 2.6% in June. Core inflation was also 2.6%, goods inflation 1.7% and services 3.6%. The direction is encouraging, and real regular pay rose about 0.3% after the broader CPIH measure. Services show why the Bank of England remains cautious.

Sources: Eurostat; UK Office for National Statistics; UK pay.

Central banks and borrowing costs

The ECB kept the deposit rate at 2.25%, the refinancing rate at 2.40% and the marginal lending rate at 2.65% in July. The pause followed a June increase; energy uncertainty makes rapid easing unlikely.

The Bank of England held Bank Rate at 3.75% by six votes to three; the minority preferred 4.00%. Markets therefore face a higher-for-longer risk. Existing fixed-rate borrowers are protected until refinancing, while floating-rate debt, commercial property and smaller businesses feel the pressure sooner.

Euro-area corporate borrowing costs rose to 3.79% and new housing loans averaged 3.51%. UK mortgage approvals fell to 58,200, below their six-month average. Financial conditions are not loose.

Sources: ECB decision; Bank of England decision; Euro-area loan rates; UK money and credit.

Government finances and bond-market pressure

The euro-area deficit narrowed to 3.1% of output in the first quarter and debt stood at 88.9%. The average hides large differences: Italy and France carry much higher debt burdens than Germany. Investors should expect country bond spreads to respond differently to weak growth or higher energy costs.

UK public borrowing was £16.0 billion in June, £7.9 billion lower than a year earlier, helped by lower inflation-linked debt costs. One month does not remove the fiscal constraint. Large refinancing needs and Bank of England gilt sales keep government yields important for mortgages and equity valuations.

Sources: Eurostat government accounts; European Commission forecast; UK public finances.

Banks, credit and who can borrow

Euro-area bank lending is expanding. Adjusted loans to companies grew 4.0% in June and household loans 3.0%. Banks nevertheless tightened business standards moderately, with the greatest caution around vehicles and energy-intensive manufacturing. Loan growth therefore favours stronger companies rather than every borrower.

UK net mortgage borrowing rose to £7.7 billion in June, but approvals remained soft. Banks reported lower demand from small and medium-sized businesses and expected little change in the third quarter. Consumer credit and housing can support bank income, while SMEs still face a weaker transmission channel.

Sources: ECB credit; ECB bank lending survey; Bank of England money and credit; UK credit-conditions survey.

Company profits and stock-market leadership

With 54% of STOXX 600 companies reported by 31 July, FactSet estimated earnings growth near 23% and sales growth near 10%, led by energy and technology. A few large companies make the aggregate less broad than it appears.

The STOXX Europe 600 stood at 658.19 on 6 August, up about 10% in 2026. MSCI Europe traded near 15 times expected earnings; the UK was near 13 times with a higher dividend yield. Cheaper does not mean risk-free.

Figure 2. July 2026 equity returns show a sharp style and sector split.

WHAT THIS TELLS US The market rewarded lower valuations, dividends and domestic cyclicals. Technology's fall was amplified by concentration: ASML and SAP dominate the European sector. Better index earnings do not mean every company participated.

Sources: MSCI Europe; MSCI UK; MSCI Europe Value; MSCI Europe technology; STOXX; FactSet earnings.

EUR, GBP and the translation effect

From 30 June to 6 August, the euro rose about 1.3% against the dollar to $1.154, while sterling rose about 1.9% to roughly $1.347. A stronger home currency reduces the local-currency value of overseas profits, but lowers the cost of dollar-priced imports such as energy.

For a sterling investor, euro-area assets also carry EUR/GBP risk; one euro bought £0.857 on 6 August. For Kenya, the Central Bank of Kenya's indicative rates were about KSh149 per euro and KSh174 per pound. Currency gains raise remittance and export values in shillings while increasing European import bills.

Sources: ECB EUR/USD; ECB EUR/GBP; Central Bank of Kenya.

Who benefits and who faces pressure?

WHAT THIS TELLS US The recovery helps banks, value shares and selected consumer businesses first. Manufacturing, property and smaller borrowers need lower energy or financing costs before the improvement becomes broad.

Where is money moving?

Confirmed European fund-market data show May UCITS inflows of €79 billion. Long-term funds received €70 billion: bond funds €35 billion and equity funds €18 billion. UCITS exchange-traded funds received €39 billion. These are subscriptions and withdrawals, not market returns.

UK retail investors added £3.8 billion in June, the strongest month since August 2021. Fixed-income funds took £2.26 billion, money-market funds £924 million and mixed assets £1.20 billion, while equity funds lost £1.11 billion. Europe equity funds lost £208 million and UK equity funds £561 million.

Figure 3. Confirmed UK retail fund flows, June 2026.

WHAT THIS TELLS US The money data are more defensive than the equity-price rally. Investors preferred trackers, bonds, diversified funds and cash-like assets. Better UK and value-share returns came despite continued withdrawals from active equities.

Sources: European Fund and Asset Management Association; UK Investment Association.

Africa and Kenya transmission

A firmer Europe supports African tourism, horticulture, manufactured goods and services. Exporters benefit where sales are in euros or pounds and costs are local. Weak German manufacturing limits supply-chain demand.

Higher European energy costs travel through freight, fertiliser, machinery and medicine prices. Stronger euro and sterling rates add to the import bill. Remittances move oppositely: the same foreign income converts into more shillings.

European banks remain important sources of African trade finance and capital. Higher rates make funding selective: established exporters obtain credit first, while smaller firms and high-debt countries face more refinancing pressure.

What could change this view?

Base case. Euro-area growth remains positive but uneven, UK consumption improves slowly, and both central banks hold rates until inflation gives clearer evidence of returning to 2%.

Positive case. Energy inflation falls, Germany's investment turns positive and UK services inflation drops below 3%. Broader earnings and easier credit would then support smaller companies and property.

Negative case. Energy rises, unemployment increases or France and Italy face higher refinancing costs. Central banks would then choose between weak growth and persistent inflation.

Measurable tests. Watch euro-area retail and industrial production, UK payroll employment, services inflation in both regions, business-loan standards, and whether earnings growth spreads beyond energy and a few large companies.

What to watch next

Scheduled official events known at the data cut-off. Dates can change.

WHAT THIS TELLS US The next test is breadth. A durable improvement requires growth outside Spain and UK retail, falling services inflation, and borrowing conditions that improve for smaller companies as well as large borrowers.

Final Desk takeaway

Europe is strengthening from a weak base, with too much dependence on Spain and services. UK households benefit as wages beat inflation, yet softer employment and investment limit confidence. Inflation prevents cheap money.

The signal is selective. Banks, value shares and cash-generating companies have support; expensive growth, property and energy-intensive manufacturers remain exposed. Fund flows are defensive even as equities rise. A stronger euro and pound help Kenyan exporters and remittance recipients, but raise import costs. Judge the next month on broader activity, services inflation and actual credit transmission.

Data notes

Growth, inflation, lending and flow data use different release periods. Preliminary GDP can be revised. Equity returns are index performance; fund flows are confirmed subscriptions and withdrawals. Earnings growth is an aggregate estimate based on companies reported by 31 July. Currency effects depend on each investor's home currency and hedging. This report is educational and not personalised advice.

Sources

Eurostat GDP and inflation

Eurostat inflation (July flash)

UK GDP (ONS monthly estimate, May 2026)

UK retail sales (ONS, June 2026)

UK labour market (ONS, July 2026)

UK pay (ONS average weekly earnings, July 2026)

UK business investment (ONS quarterly economic commentary)

UK consumer price inflation (ONS, June 2026)

Germany (Destatis)

France (INSEE)

Italy (ISTAT)

Spain (INE)

ECB decision

Bank of England decision

Euro-area loan rates (ECB MFI interest rates)

ECB credit (monetary developments)

ECB bank lending survey

Bank of England money and credit, June 2026

UK credit-conditions survey, Q2 2026

Eurostat government accounts

European Commission spring 2026 economic forecast

UK public finances (ONS, June 2026)

MSCI Europe

MSCI UK

MSCI Europe Value

MSCI Europe information technology

STOXX Europe 600

FactSet earnings — STOXX 600 Q2

ECB EUR/USD reference rate

ECB EUR/GBP reference rate

Central Bank of Kenya forex rates

European Fund and Asset Management Association

UK Investment Association

ONS release calendar

Eurostat release calendar

ECB calendar

Bank of England MPC dates

Public investment research. Educational use only; not personalised investment advice.