EU Economy:Weekly Commentary – November 10, 2023
Eurozone View Synopsis
Given weakness in the economy, we do not expect rates to rise. ECB's next likely move would be a rate cut in Q3 2024.
The economy in the EU is weak and the most recent data indicates that the current level of interest rates is appropriate. We note that that whilst the trend for inflation is declining, other factors such as manufacturing and services purchasing managers' indices (PMIs) remain in contraction territory and retail sales are dropping indicating potential weakness in consumer demand. Overall, in the upcoming meeting on the 14th of December 2023, we expect that the European Central Bank (ECB) will maintain the rates at their current level and hold them for a longer period than people expect. Furthermore, we think it is more likely that the next move might be rate cuts starting around the third quarter of 2024 rather than a move higher.
The economy in the EU is weak and the most recent data indicates that the current level of interest rates is appropriate. We note that that whilst the trend for inflation is declining, other factors such as manufacturing and services purchasing managers' indices (PMIs) remain in contraction territory and retail sales are dropping indicating potential weakness in consumer demand. Overall, in the upcoming meeting on the 14th of December 2023, we expect that the European Central Bank (ECB) will maintain the rates at their current level and hold them for a longer period than people expect. Furthermore, we think it is more likely that the next move might be rate cuts starting around the third quarter of 2024 rather than a move higher.
European Central Bank
ECB indicates that rates will be held due to two factors: 1. Expectation of an economic contraction or a standstill in the Q4 2023; 2. Depositors need to mainatin yield to encourage savings and bring inflation to the target level.
The Vice President of the European Central Bank, Luis de Guindos, emphasized last Tuesday that when the institution raises interest rates, it aims to make savings more appealing in comparison to spending and to ensure that deposits yield returns. Without an increase in deposit rates, it becomes challenging to encourage saving over spending, which is crucial for curbing inflation.
De Guindos highlighted that economic stagnation is likely to persist in the fourth quarter following a marginal decrease in the preceding quarter. Economic growth in the Eurozone fell below expectations in the third quarter and is projected to remain subdued or negative in the final quarter of the year.
"In the third quarter, we observed a rate of -0.1%. Whether it's +0.1% or -0.1%, it holds little significance, but it represents a virtually stagnant situation. We anticipate this trend to continue in the fourth quarter," mentioned De Guindos.
The Vice President of the European Central Bank, Luis de Guindos, emphasized last Tuesday that when the institution raises interest rates, it aims to make savings more appealing in comparison to spending and to ensure that deposits yield returns. Without an increase in deposit rates, it becomes challenging to encourage saving over spending, which is crucial for curbing inflation.
De Guindos highlighted that economic stagnation is likely to persist in the fourth quarter following a marginal decrease in the preceding quarter. Economic growth in the Eurozone fell below expectations in the third quarter and is projected to remain subdued or negative in the final quarter of the year.
"In the third quarter, we observed a rate of -0.1%. Whether it's +0.1% or -0.1%, it holds little significance, but it represents a virtually stagnant situation. We anticipate this trend to continue in the fourth quarter," mentioned De Guindos.
PMIs and European confidence
Manufacturing and service sectors remain in contraction territory, with Germany, Italy and France struggling. High prices of goods are affecting demand from consumers.
Preliminary data for the composite Purchasing Managers' Index (PMI) at the beginning of the fourth quarter indicated that the bloc entered the last quarter of 2023 on a defensive note, marking the lowest level since late 2020. Additionally, retail sales saw a 0.3% decline in October, continuing a trend of decreasing volumes for three consecutive months since late 2021. This decline is partly due to weakened overall demand and, to some extent, the result of excessive spending on goods in 2020 and early 2021. However, the overspending has slowed, and the current dip in demand is due to the high prices of goods.
Preliminary data for the composite Purchasing Managers' Index (PMI) at the beginning of the fourth quarter indicated that the bloc entered the last quarter of 2023 on a defensive note, marking the lowest level since late 2020. Additionally, retail sales saw a 0.3% decline in October, continuing a trend of decreasing volumes for three consecutive months since late 2021. This decline is partly due to weakened overall demand and, to some extent, the result of excessive spending on goods in 2020 and early 2021. However, the overspending has slowed, and the current dip in demand is due to the high prices of goods.
The Eurozone's composite PMI remains in contraction territory at 46.5, hitting a 35-month low, while the services sector fell to 47.8, marking a 32-month low. Even the leading European power, Germany, continues to struggle. Its Composite PMI dropped to 45.9 in October from the previous month's 46.4, marking the fourth consecutive month of contraction. Additionally, the services PMI for Germany shifted into contraction territory from 50.3 in September. The industrial sector in Germany is facing significant challenges, with industrial production declining for the fifth consecutive month in September, marking a 1.4% decrease from August and a 3.7% drop annually. Despite an unexpected increase in factory orders by 0.2% in September, Germany's overall economic weakness persists. France and Italy are facing similar situations with both composite and services PMIs continuing to contract.
The prevailing economic conditions are weak, evident through declining manufacturing and services PMIs. Considering this, it is our belief that the economy is fragile enough to warrant the European Central Bank (ECB) maintaining the current interest rates. Altering the rates might further strain the economy, potentially leading it into a recession—an outcome that already seems likely.
The prevailing economic conditions are weak, evident through declining manufacturing and services PMIs. Considering this, it is our belief that the economy is fragile enough to warrant the European Central Bank (ECB) maintaining the current interest rates. Altering the rates might further strain the economy, potentially leading it into a recession—an outcome that already seems likely.
Inflation
Positive news on inflation, with the trend pointing to a decline. However, oil, natural gas and house prices remain a concern and may temper inflation reaching the ECB target. Overall, we expect the ECB to maintain interest rates at current levels.
The Eurozone Producer Price Index (PPI) year-over-year recorded a drop of 12.4 per cent, while month-over-month it rose 0.5 per cent. These figures align with efforts to achieve the 2 per cent inflation target. Besides, we anticipate that the ongoing downward trend in oil and natural gas prices won't counteract the prevailing disinflationary pressures.
In Germany, the consumer price index (CPI) reflected an inflation rate of +3.8 per cent in October, marking a continuous slowdown and reaching the lowest level since August 2021. Although inflation persists at high levels, consumers are still grappling with elevated prices in food and energy, a situation that might endure due to global tensions. Nonetheless, when compared to the previous year, food and energy prices are lower. Notably, the primary contributor to high inflation in Germany remains food prices, which surged by 6.1 per cent in October.
Our expectation for inflation within the EU is that it will continue to align with the trajectory towards the 2 per cent target. Natural gas and pre-oil prices are not going to raise inflation, so the European Central Bank (ECB) could choose to maintain interest rates at their current level due to the dual concerns of declining inflation and a weakened economy, both concerns of the ECB. As such, we believe that we need to monitor closely these factors in the coming months.
The Eurozone Producer Price Index (PPI) year-over-year recorded a drop of 12.4 per cent, while month-over-month it rose 0.5 per cent. These figures align with efforts to achieve the 2 per cent inflation target. Besides, we anticipate that the ongoing downward trend in oil and natural gas prices won't counteract the prevailing disinflationary pressures.
In Germany, the consumer price index (CPI) reflected an inflation rate of +3.8 per cent in October, marking a continuous slowdown and reaching the lowest level since August 2021. Although inflation persists at high levels, consumers are still grappling with elevated prices in food and energy, a situation that might endure due to global tensions. Nonetheless, when compared to the previous year, food and energy prices are lower. Notably, the primary contributor to high inflation in Germany remains food prices, which surged by 6.1 per cent in October.
Our expectation for inflation within the EU is that it will continue to align with the trajectory towards the 2 per cent target. Natural gas and pre-oil prices are not going to raise inflation, so the European Central Bank (ECB) could choose to maintain interest rates at their current level due to the dual concerns of declining inflation and a weakened economy, both concerns of the ECB. As such, we believe that we need to monitor closely these factors in the coming months.
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No representation or warranty, express or implied, is made by Dolfin Fund Management Ltd or any of its directors, officers or employees as to the accuracy, completeness or fairness of the information in this document and no responsibility or liability is accepted for any such information (save in respect of fraudulent representation or warranty).
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