EU Economy: Weekly Commentary – December 01, 2023
Eurozone View Synopsis
Given Europe's current fragility and the increasing likelihood of a recession, the ECB is indicating that it may pause in its hiking cycle. With stagnation a real possibility, economic data is indicating that rate cuts may occur in the third quarter of 2024.
The EU economy is fragile and the downward trend in inflation along with signs of a weak economy provide room for the ECB to pause. Key indicators are collectively indicating economic difficulties; Manufacturing and Services PMI remain in contraction; unemployment is on the increase in some key regions such as Germany or Italy and consumer confidence is not providing any relief being below the historical average. Overall, the scenario the Eurozone could be facing is a period of stagnation or decline for the coming quarters. As such at the next meeting of the European Central Bank on December 14, 2023, we anticipate a decision to maintain interest rates at their current level. Thoughts may be shifting on how to avert (or exit promptly) a recession, and with declines in inflation, whilst the broader economy is suffering, there is a potential risk that talks could turn to rate cuts happening than the market currently expects.
The EU economy is fragile and the downward trend in inflation along with signs of a weak economy provide room for the ECB to pause. Key indicators are collectively indicating economic difficulties; Manufacturing and Services PMI remain in contraction; unemployment is on the increase in some key regions such as Germany or Italy and consumer confidence is not providing any relief being below the historical average. Overall, the scenario the Eurozone could be facing is a period of stagnation or decline for the coming quarters. As such at the next meeting of the European Central Bank on December 14, 2023, we anticipate a decision to maintain interest rates at their current level. Thoughts may be shifting on how to avert (or exit promptly) a recession, and with declines in inflation, whilst the broader economy is suffering, there is a potential risk that talks could turn to rate cuts happening than the market currently expects.
Inflation commentary.
Inflation is on the decline, altering the landscape for the ECB and the focus may be on how to avert stagflation or a recession with economic data rapidly. Rate cuts could occur sooner than most anticipate but our base case is a pause until at least Q3 2024.
Inflation is declining and recent data from some of the important economies such as Italy, France and Germany, support this trend. Weakening demand in Germany due to high level of interest rates should lead to further price declines in the coming months with sales price expectations in the services sector declining. Energy prices around the EU fell the most, – 11.2 per cent during November, however, inflation in services remains somewhat sticky and is not falling as much as expected.
On the other side of the coin, we do note that in France, an uptick of 2.1 per cent MoM was seen in fresh foods and the rate of core inflation declines is moderating, declining just 0.6 per cent month on month (3.6 per cent prior). Both of these will be closely monitored to see if inflation will continue its decline to the desired ECB target.
Overall, it appears that current interest rate levels are doing their job and are restrictive enough to reduce inflation to the 2 per cent target. We believe that inflation will follow the same trend in the coming months. We may see inflation close to the target sooner than expected, however we are starting to observe a sharp drop in growth.
Inflation is declining and recent data from some of the important economies such as Italy, France and Germany, support this trend. Weakening demand in Germany due to high level of interest rates should lead to further price declines in the coming months with sales price expectations in the services sector declining. Energy prices around the EU fell the most, – 11.2 per cent during November, however, inflation in services remains somewhat sticky and is not falling as much as expected.
On the other side of the coin, we do note that in France, an uptick of 2.1 per cent MoM was seen in fresh foods and the rate of core inflation declines is moderating, declining just 0.6 per cent month on month (3.6 per cent prior). Both of these will be closely monitored to see if inflation will continue its decline to the desired ECB target.
Overall, it appears that current interest rate levels are doing their job and are restrictive enough to reduce inflation to the 2 per cent target. We believe that inflation will follow the same trend in the coming months. We may see inflation close to the target sooner than expected, however we are starting to observe a sharp drop in growth.
Manufacturing commentary.
The manufacturing sector is showing signs of improvement in some countries. Nevertheless, the dwindling employment in factories suggests a rise in unemployment in the forthcoming months.
The EU's manufacturing PMI surged to 44.20 points in November (43.10 in October), surpassing market expectations. This upturn marks the sector's highest value in half a year. Despite the ongoing deceleration in the euro area's manufacturing activity, various indicators like output, new orders, purchasing, and inventories showed reduced contractions. Simultaneously, business confidence climbed to a three-month peak. However, factory employment dipped to levels not seen since August 2020. On a positive note, input prices dropped, enabling manufacturers to lower their selling prices.
Germany and France displayed signs of improvement, with declines softening. Conversely, Italy experienced intensified deceleration, underscoring the challenges Europe faces. Despite the continued decline in industrial production throughout the euro area in November, the pace slowed, marking the slowest rate since May. This milder decline coincided with a less severe contraction in new orders, while the decrease in new export orders also moderated.
The EU's manufacturing PMI surged to 44.20 points in November (43.10 in October), surpassing market expectations. This upturn marks the sector's highest value in half a year. Despite the ongoing deceleration in the euro area's manufacturing activity, various indicators like output, new orders, purchasing, and inventories showed reduced contractions. Simultaneously, business confidence climbed to a three-month peak. However, factory employment dipped to levels not seen since August 2020. On a positive note, input prices dropped, enabling manufacturers to lower their selling prices.
Germany and France displayed signs of improvement, with declines softening. Conversely, Italy experienced intensified deceleration, underscoring the challenges Europe faces. Despite the continued decline in industrial production throughout the euro area in November, the pace slowed, marking the slowest rate since May. This milder decline coincided with a less severe contraction in new orders, while the decrease in new export orders also moderated.
Labour market prospectus.
As the economy cools, we begin to see unemployment rates rising in countries like Germany and Italy. This trend of rising unemployment and a weakening labour market is expected to continue.
Unemployment in Europe has remained steady at 6.5 per cent compared to September. However, the situation for young people is increasingly concerning, with unemployment rising to 14.8 per cent in the EU and 14.9 per cent in the euro area. November saw Germany's unemployment rate at 5.9 per cent, surpassing expectations and marking its highest level in two and a half years. Similarly, Italy experienced a hit, reaching 7.8 per cent, a figure not witnessed since June of this year.
These figures underscore how economic fragility is beginning to impact the job market significantly. We anticipate further escalations in unemployment levels in the upcoming months, while the economy weakens further.
Unemployment in Europe has remained steady at 6.5 per cent compared to September. However, the situation for young people is increasingly concerning, with unemployment rising to 14.8 per cent in the EU and 14.9 per cent in the euro area. November saw Germany's unemployment rate at 5.9 per cent, surpassing expectations and marking its highest level in two and a half years. Similarly, Italy experienced a hit, reaching 7.8 per cent, a figure not witnessed since June of this year.
These figures underscore how economic fragility is beginning to impact the job market significantly. We anticipate further escalations in unemployment levels in the upcoming months, while the economy weakens further.
Consumer Confidence.
Consumer sentiment is increasing but we note that employment expectations are moderately down and could lead to future declines.
Improvements were seen in the Economic Sentiment Indicator across the EU, primarily due to increased confidence among consumers and construction managers.
France and Germany saw slight enhancements in consumer sentiment. Despite an overall rise in the standard of living among French consumers, worries about unemployment reached their highest point since August 2021. In Germany, consumer sentiment showed a slight uptick after three months of decline yet concerns persist regarding food inflation and its potential impact on purchasing power.
Both economies continue to lag behind normal levels, France at 87 and Germany at -27.8, indicating that a significant economic upturn might not happen until consumer sentiment reaches the historical average of 100 in France and Germany consumer sentiment index needs to cross the positive side.
Forecasts anticipate increased prices in services within the EU, including in construction, while industry and retail trades expect declines. This divergence could potentially aid countries like Germany in bolstering their manufacturing sectors. However, for the second consecutive month, consumers' price perceptions for the upcoming twelve months have eased.
Consumer confidence could deteriorate further as the economic situation worsens as we expect it will in Europe. We expect unemployment to increase, and this would mean less consumer spending.
Improvements were seen in the Economic Sentiment Indicator across the EU, primarily due to increased confidence among consumers and construction managers.
France and Germany saw slight enhancements in consumer sentiment. Despite an overall rise in the standard of living among French consumers, worries about unemployment reached their highest point since August 2021. In Germany, consumer sentiment showed a slight uptick after three months of decline yet concerns persist regarding food inflation and its potential impact on purchasing power.
Both economies continue to lag behind normal levels, France at 87 and Germany at -27.8, indicating that a significant economic upturn might not happen until consumer sentiment reaches the historical average of 100 in France and Germany consumer sentiment index needs to cross the positive side.
Forecasts anticipate increased prices in services within the EU, including in construction, while industry and retail trades expect declines. This divergence could potentially aid countries like Germany in bolstering their manufacturing sectors. However, for the second consecutive month, consumers' price perceptions for the upcoming twelve months have eased.
Consumer confidence could deteriorate further as the economic situation worsens as we expect it will in Europe. We expect unemployment to increase, and this would mean less consumer spending.
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This document may not be reproduced, redistributed or passed on to any other person or published, in whole or in part, for any purpose without the prior written consent of Dolfin Fund Management Ltd.
Dolfin Fund Management Ltd, a company registered in Malta (registered number C71750), authorised and regulated by the Malta Financial Services Authority (licence number IS71750).
Copyright © 2023 Dolfin Fund Management Ltd. All rights reserved.