EU Economy: Weekly Commentary – January 22, 2024
Eurozone View Synopsis
More pressure on the industrial sector due to the tensions in the Middle East. ECB is between a rock and a hard place facing an inflation vs recession decision. By not cutting rates, the economy will continue to suffer and may lead to a recession but if they cut too soon inflation may spark higher. Lagarde mentioned that cuts may come in summer.

The economy is weak, and inflation rose in December. The European Central Bank (ECB) faces a challenging decision. The dilemma lies in the consequences of not lowering rates, which could increase economic hardships and lead to a recession. Conversely, reducing rates too soon may exacerbate inflation, especially with heightened inflationary tensions stemming from the conflict in the Middle East. Our projections indicate that rate cuts may be in the latter half of the year. This perspective finds support in remarks made by Christine Lagarde in Davos, where she hinted at the possibility of cuts in the summer.
Inflation commentary
Ongoing data indicates a widespread surge in inflation. The escalation of inflationary pressures persists, primarily attributed to tensions in the Red Sea. The potential resurgence of energy prices poses a significant threat to Europe, especially Germany, and could catalyze a recession in 2024.

The euro area inflation rate was 2.9 per cent in December, up from 2.4 per cent in November. Europe's annual inflation was 3.4 per cent in December 2023, up from 3.1 per cent in November. The biggest contribution to the annual euro area rate inflation rate came from services, which was up 1.74 per cent, followed by food, alcohol, and tobacco (1.21 per cent). Furthermore, the inflation could be uptick more in the coming months due to Red Sea tension. The prices of goods, freight, and insurances are already increasing.

Inflation in Germany rebounded in December, reaching 3.7 per cent, which represents an increase of 0.5 per cent from the 3.2 per cent marked in November. Annual inflation for 2023 in Germany stands at 5.9 per cent, which represents a somewhat more moderate increase than that of 2022, specifically 1 per cent less. Food prices were the main drivers of this rise, which have risen 12.4 per cent on average during 2023. If we look at underlying inflation, it stood at 5.1 per cent, which increased compared to the year 2022, where it stood at 3.8 per cent. In contrast, in Italy, inflation seems to continue the downward trend. The decrease in annual terms comes thanks to the drop in pressure on energy prices, which rose 1.2 per cent compared to 50.9 per cent in 2022. However, in monthly terms, it has been noted a slight increase, came due to the increase in prices of transportation services, unprocessed foods, and non-durable goods.

In general, we are seeing a general rebound in inflation in monthly terms and some cases also annually. However, the decline in inflation isn't necessarily linear. That re-acceleration of core inflation in Europe in December 2023 is an important reminder of just how difficult the final phase of the inflation fight can be. We believe that the ECB will maintain high rates until the second half of the year since they are not going to risk cutting to see a new rebound in inflation. Furthermore, supporting our view, European Central Bank President Lagarde has indicated that interest cuts might be on the table by the summer, an insight gleaned from her interview at the World Economic Forum in Davos.
Industrial production commentary
The industrial sector is poised for ongoing challenges in 2024, primarily driven by geopolitical tensions. Worries about global trade disruptions persist, fuelled by the conflict in the Middle East.

In November, Eurozone industrial production declined by 0.3 per cent month-on-month (MoM), aligning with market forecasts. Similarly, the European Union experienced a 0.2 per cent decrease. On an annual basis, the declines were more pronounced, with the Eurozone and EU experiencing drops of 6.8 per cent and 5.8 per cent, respectively. The persistent downtrend underscores the challenges faced by the economy, particularly within the industrial sector. The current economic landscape, coupled with shipping-related issues, is anticipated to exacerbate these difficulties. Notably, November 2023 witnessed a substantial year-over-year decrease in industrial production across various categories: 10.3 per cent for capital goods, 8.0 per cent for durable consumer goods, 6.9 per cent for non-durable consumer goods, and 5.2 per cent for intermediate goods. In contrast, energy production demonstrated a modest uptick of 0.8 per cent.

We foresee the industrial sector exerting substantial pressure on the economy during the initial half of the year. Furthermore, the difficulties within this sector are set to intensify, primarily attributed to the repercussions of issues in the Red Sea on global trade.
Consumer spending commentary.
Germany is grappling with challenges and experiencing declines throughout 2023. The industrial sector shows no signs of recovery, and the outlook for the near future is not particularly encouraging.

In 2023, the German GDP contracted by 0.3 per cent, primarily attributed to factors such as high inflation, escalating interest rates, and elevated energy costs. Despite recent declines in prices, persistently high prices throughout the economy acted as a constraint on economic growth. Unfavourable financing conditions, driven by rising interest rates, coupled with weakened domestic and foreign demand, took a toll on overall economic performance. Throughout 2023, the decline in production within the energy supply and manufacturing sectors, which are the main sectors in the country, both in negative territory, significantly contributed to this contraction. Even in the early months of 2024, the manufacturing sector, constituting nearly 85 per cent of the industry, continues to grapple with challenges, with additional hurdles expected due to ongoing tensions in key shipping routes.

However, amidst these challenges, there are positive contributors to the economy. The automotive industry and manufacturers of other transport equipment made positive contributions. Most service sectors expanded their economic activities compared to the previous year, providing a boost to the economy in 2023, although the overall growth was weaker than in the preceding two years. Consumer spending contracted in 2023, with a 0.8 per cent decrease attributed to high prices. The government also curtailed expenses by 1.7 per cent, marking the first reduction in almost two decades. Notably, Germany managed to reduce its public debt by approximately 14 billion compared to the same period in the previous year.

Overall, our perspective on Germany points to the European powerhouse plunging into another year of stagnation, with manufacturing sector suffering and consumer spending dropping. Even now there are more challenges ahead with new geopolitical tensions.
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