EU Economy: Weekly Commentary – November 17, 2023

Eurozone View Synopsis
We do not expect rates to rise in Europe due to the weakness exhibited and we see that the probability of recession increases. On balance, our expectation is ECB's next likely move would be a rate cut in the third quarter of 2024..

The EU economy appears frail, and recent data supports De Guindos' assertion that the present interest rates are fitting. We observe a downward trend in inflation alongside stagnant economic growth. Both manufacturing and services PMIs remain in contraction zones, while industrial production and retail sales are on a downward spiral. These indicators collectively signal economic difficulties, hinting at a phase of stagnation for the coming couple of quarters. Considering the European Central Bank's upcoming meeting on December 14, 2023, we anticipate a decision to hold interest rates at their current level, possibly extending these levels longer than anticipated. Moreover, our outlook suggests a higher likelihood of future rate cuts, potentially commencing in the third quarter of 2024, rather than a move towards rate hikes.
European Central Bank Commentary
The ECB's stance increasingly shows that interest rates will remain high for longer than some expect, as Luis De Guindos mentioned last Monday. The ECB is seeing the economy weaken and inflation on track to reach its target.

Whilst inflation shows a decrease from last year, it persists at high levels. However, the euro area's growth prospects have dimmed, impacted by a global deceleration in growth momentum and tighter financial conditions putting pressure on both consumer spending and investment. Presently, inflation hovers below 3 per cent, yet Luis de Guindos remarked last Monday about the expected short-term rebound in the months ahead due to the base effects of the significant surge in energy and food prices in autumn 2022. However, a lasting disinflationary pattern is foreseen in the medium term, with uncertainty looming over energy prices intensified by geopolitical tensions and fiscal measures' impacts.

Though the European labour market retains relative strength, signs of gradual weakening are emerging. Job opportunities are increasingly scarce, and recent projections indicate a continued decline in employment expectations across both manufacturing and service sectors in October.

The ECB remains resolute in bringing inflation back to its 2 per cent target, evaluating the impact of its current interest rates. According to Luis de Guindos, maintaining these interest rates for a long period would significantly contribute to this objective. The commitment to this goal remains firm, with close monitoring of the evolving situation.

EU economic growth prospects
The EU is currently in a phase of stagflation. Based on the data we have on the table; it seems that this pattern will persist at least until the second quarter of 2024.

In the third quarter of 2023, the Eurozone experienced a slight 0.1 per cent dip in GDP, while the EU remained steady compared to the previous quarter. Year-on-year adjusted GDP displayed a modest resurgence of 0.1% in both the euro area and the EU, following a 0.5% increase in the euro area and 0.4% in the EU in the prior quarter.

As anticipated, the EU seems to be in a stagflationary phase. Among the prominent economies within the Eurozone, Germany recorded a 0.1 per cent GDP decline, France exhibited marginal growth with a 0.1 per cent increase, and Italy maintained stability at 0.0 per cent.

Our outlook foresees sustained economic tensions in the EU. We're observing diminishing PMIs, weakening consumer confidence, sluggish retail sales, and geopolitical strains in regions like the Middle East and Ukraine. The stagflation will persist for the fourth quarter of 2023 and the first quarter of 2024. Furthermore, if these conditions persist, the likelihood of a recession escalates.

Inflation continues on a downward trend, are this trend is supported by the ongoing decrease in energy prices. Nonetheless, the current concern stems from services that aren't decelerating as swiftly as hoped. With Inflation still above target, the ECB is expected to maintain rates at current levels.

October witnessed a drop in inflation within the Eurozone to 2.9 per cent from September's 4.3 per cent, while in the EU, it decreased to 3.6 per cent from 4.9 per cent in September. This decline was largely influenced by an 11.2 per cent reduction in energy prices. However, the stability in service prices limited a more significant decline, with inflation services only slightly dipping by 0.1 per cent in October.

The shift from 4.3 per cent to 2.9 per cent in October was primarily due to the lingering impact of high energy prices from the previous year, contributing to a decline in core inflation as well. Despite concerns persisting regarding high service inflation rates, these figures suggest that the current annual core inflation of 4.2 per cent is likely to decrease in the coming months, as businesses do not anticipate substantial price hikes.

At present, we do not foresee the ongoing conflicts in the Middle East and Ukraine significantly escalating energy prices but this could change due to the increased demand expected over the winter. Overall, the trend in inflation appears to be downward. As a result, the European Central Bank is expected to maintain rates at the upcoming meeting on December 14.

Labour market
The EU labour market remains resilient with the employment rate increased in the third quarter of 2023. The problems would come if the wages increase despite a tight labour market.

Employment in Q3 saw a modest rebound of 0.3 per cent in the euro area and 0.2 per cent in the EU. Comparatively, compared to the third quarter of the previous year, there was a 1.4 per cent increase in employment in the euro area and 1.3 per cent in the EU, following increases of 1.3 per cent and 1.1 per cent, respectively, in the second quarter of 2023. Despite stagnating output growth throughout the EU this year, the labour market has shown remarkable resilience.

Our projection suggests that the EU labour market is likely to remain resilient for the foreseeable future, although we may not see wage increases from companies. However, real wages will be higher because inflation is declining. If the labour market maintains its current stability and economic indicators persist along similar lines, it is likely that the European Central Bank (ECB) will interpret the persistent weakness of the economy and end its upward cycle.
Industrial production
The probability of a recession is increasing with industrial production showing a downward trend, indicating that the economy is struggling and weakening.

Industrial production in the EU and the euro area continues its downward trajectory. Year-on-year, the euro zone's industrial output dropped by 6.9 per cent, a significant decline from the previous month's 5.5 per cent. Similarly, month-over-month figures reveal a concerning trend, with a decrease of 1.1 per cent following a limited growth of 0.6 per cent in August. The EU experienced a 0.9 per cent dip compared to August and a substantial 6.1 per cent decline from a year ago.

The majority of countries are grappling with both annual and monthly contractions, painting a bleak picture for the industry's immediate future. Unfortunately, there's little indication of improvement on the horizon. If this persistent decline continues, the manufacturing index might plummet once more in the final quarter of the year.

The EU economy exhibits vulnerability, evident in the ongoing slump in industrial production alongside PMIs (which is still signalling contraction). Forecasts indicate a potential worsening in the last quarter, with PMIs likely to remain in recessionary territory. As such, the ECB is balancing these factors and its fight against inflation and as such seems committed to maintaining interest rates at current levles, as highlighted by De Guindos in his recent meeting.

Our perspective aligns with the anticipation of a continued struggle for the European economy in the upcoming months. With the economy in a weakened state and inflation on a downward trajectory, the ECB has no incentive to continue with a tightening of monetary conditions and interest rates are adequate.
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