EU Economy: Weekly Commentary – December 18, 2023
Eurozone View Synopsis
ECB ruled out the scenario of a recession from their thoughts but the fragility of the economy means that a recession is a possibility.

With inflation falling and considering the weakness of the economy there is a rationale to lower interest rates. We note that PMI continues to decline but consumer confidence has improved due to lower inflation. The base case scenario is that the Eurozone faces a period of stagnation in the coming quarters and that rates will remain on hold.
ECB Meeting
No surprise from the ECB, with rates unchanged but ruled out a recession. ECB remains data dependent maintains types and continues to monitor upcoming data to decide on the next steps.

Lagarde's speech on the 14th of December struck a more hawkish tone compared to Powell's speech. The ECB opted to keep interest rates steady. Whilst we are seeing the Fed start to consider rate cuts, Lagarde emphasised that rate cuts aren't currently under consideration and remarked on their data-dependence. Given the potential divergence between the Fed and ECB, it is fair to expect the Euro will continue to strengthen against the USD.

The ECB does anticipate a slight uptick in short-term inflation, but foresee a gradual decline throughout 2024, reaching 2.1 per cent by 2025 and 1.9 per cent in 2026. Projected growth remains conservative: 0.6 per cent for 2023, up to 0.8 per cent in 2024, and a more robust 1.5 per cent for 2025 and 2026. Importantly, the ECB doesn't foresee an economic recession in the coming months.
Manufacturing commentary
The manufacturing sector remains in contractionary territory. The economy continues to show a lot of weakness, which does not agree with the scenario painted by the ECB of no recession.

The Eurozone PMI witnessed another contraction, with the services PMI dropping from 48.7 to 48.1 and the manufacturing PMI sliding from 47.6 to 47 in November. This decline in business activity throughout December challenges the ECB's assertion of avoiding a recession scenario. Notably, manufacturing saw a positive reduction in input costs while services continued to face relatively high costs. Nevertheless, this reduction in business activity reflects the seventh consecutive month of dropping orders.

Employment faced its second consecutive monthly decline as companies were layoffs due to weakened demand. Manufacturing sectors experienced a seven-month streak of payroll reductions, showcasing job losses approaching some of the highest levels since 2012, discounting the pandemic months. On the other hand, service providers' hiring remained subdued, resulting in only marginal worker increases compared to the robust employment gains earlier in the year.

Key European powerhouses Germany and France showed manufacturing contractions once again as their main economic source. In Germany, December marked the sixth successive month of sub-50 contraction territory in the composite PMI, dropping from November's 47.8 to 46.7, indicating a swifter slowdown than the previous month. While manufacturing showed a slight improvement from November, services further declined. In France, the composite PMI fell to 43.7 from 44.6, signalling another private sector contraction. Besides, unemployment in the private sector rose in both countries, with Germany witnessing the fastest employment decline since August 2020 and France hitting a three-year high.

Our outlook is that manufacturing will continue to suffer until we see costs start to decline, especially shipping. Until then the index will remain firmly in contraction territory.
Consumer and market expectations
Consumer sentiment improved thanks to the decreased inflation trend. However, in early 2024 it will drop again due to increases in unemployment rate and still high interest rates.

In December, the sentiment among financial market experts regarding the eurozone's economic outlook surged significantly, marking a notable increase in the indicator to 23.0 points, a leap of 9.2 points from November. This ongoing upward trend, spanning three consecutive months, reflects a growing optimism as inflation steadily approaches its target.

Germany's ZEW indicator of economic sentiment reached a high of 12.8 in December, the most robust reading since March, surpassing November's 9.8 and market expectations set at 8.8. Notably, amidst the ongoing budget crisis, the evaluation of Germany's economic situation and prospects showed a slight yet positive uptick., which could be due to the Christmas period and decreased inflation trend. Additionally, more respondents anticipate ECB interest rate cuts in the medium term, shaping a more positive outlook.

In essence, despite the prevailing challenges, the upward trajectory in economic sentiment and consumer optimism in the Eurozone and particularly in Germany signals a growing confidence in the future economic landscape. However, the data is showing the opposite and we expect drops in the coming consumer sentiment survey.
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