EU Economy: Weekly Commentary – December 29, 2024
Eurozone View Synopsis
European Central Bank (ECB) hold rates unchanged. Consumer confidence decreases along with future expectations. The services sector saw a rebound in inflation and the manufacturing sector will be a drag on the economy in the first half of the year.

The European Central Bank has opted to keep rates unchanged. Historically, the ECB has tended to follow the path of the Federal Reserve once it starts to lower rates. This cycle may be different given the distinct economic challenges faced by the European economy, which appear more pronounced than those in the United States. Our forward-looking projections suggest the possibility of rate cuts happening in the second half of the year.
BCE rates decision
Interest rates remain unchanged. The ECB has committed to achieving a 2 per cent inflation target in the medium term and believes that the current interest rates are sufficient to achieve this objective if maintained over an extended period.

Official interest rates are held at 4.50 per cent and Inflation metrics are on track to achieve the 2 per cent target despite the rebound observed in December. Core inflation continues its descent, and monetary policy maintains its impact on financial conditions. Even so, there is a concern regarding wages, with household spending demonstrating resilience. Philip Lane, Executive Board of the European Central Bank, mentioned that wage growth can cause a second wave of inflation, with the ECB placing an importance on upcoming wage data (scheduled for April). No adjustments in interest rates are expected until summer, in line with Lagarde's statement in Davos. Remarked that the ECB has historically refrained from reducing rates before the Fed, the present circumstances present a different scenario because Europe is suffering more than the United States.

The ECB will persist in making decisions based on incoming economic and financial data, with a specific focus on wage information. Evaluation will encompass underlying inflation trends and the effectiveness of monetary policy transmission. Besides, they are gradually scaling back its asset purchase program and plans to curtail its pandemic emergency purchase program in the latter part of the year.

The decision aligns with our expectations, and we are maintaining our position that rate cuts are likely in the second half of the year. Furthermore, we anticipate Lagarde will uphold a hawkish stance to prevent the euro from depreciating against the dollar.
Consumer sentiment
Consumer confidence in the European Union is on the decline, as indicated by the latest Consumer Economic Sentiment Indicator for January 2024. In Germany, consumer confidence takes a hit at the beginning of the year. Both economic and income expectations, as well as the willingness to make purchases, suffer substantial declines.

The consumer confidence index for the eurozone has dropped to -16.1. Across the entire European Union, the same indicator stands at -16.2 for the current month, reflecting a 0.2-point decrease from December 2023. This decline occurs amidst a challenging economic landscape, escalating tensions, and the looming impact of inflationary pressures.

The Consumer Climate index in Germany plunges to -29.7 points, marking a significant 4.3-point decrease from the previous month (revised to -25.4 points). Notably, last month's upturn was predominantly driven by the Christmas period. Income expectations experience a noteworthy decline of 13.1 points, reaching -20, the lowest value since March 2023. This decrease may be attributed to a modest resurgence in inflation, combined with the reinstatement of the standard 19 per cent VAT rate in the gastronomy sector in early 2024. Furthermore, the anticipated increase in the CO2 tax for energy is poised to elevate prices, further dampening income expectations. These economic challenges exert a palpable impact on consumer spending, resulting in a decline in the willingness to make purchases.

In our view, consumer sentiment will decrease more in the coming months. Ongoing crises, conflicts, and persistently high inflation will contribute to a sense of insecurity among consumers, removing any positive shift in confidence. Germany will pass another stagnant year, even ending with another economic decrease.
Business activity commentary
Continues to grapple with challenges in the manufacturing sector, posing a drag on the overall economy until there is a reduction in rates and reduced tensions. Concurrently, inflationary pressures are on the rise in the services sector, and these are expected to extend to the manufacturing sector as the effects of disruptions in the Red Sea begin to take their toll.

Business activity experienced a decline at the slowest pace in six months in January, registering at 47.9 compared to December's 47.6. Despite this moderation, business activity remains in contractionary territory for the eighth consecutive month, primarily driven by new drops in new orders.

The reduction in production has led manufacturing companies to persist in staff cuts, resulting in eight consecutive months of layoffs. Moreover, purchasing activity for manufacturing companies has reduced for the 19th consecutive month due to decreasing demand expected in the coming months. Tensions in the Red Sea have further aggravated the situation, causing delays in supplier deadlines. Despite this disruption, average costs in the manufacturing sector continued to decrease.

The services sector witnessed an acceleration in cost increases during January, contributing to the sharpest rise in aggregate prices for products and services since May of the previous year. The inflation rate has accelerated for three consecutive months, rebounding from its thirty-two-month low recorded in October of the previous year.

In the leading economies of Europe, Germany and France, saw improvements in their manufacturing sector and drawdowns in services. The manufacturing sector in Germany showed a slight improvement, reaching 45.5 compared to December's 43.3, it remains in contraction. Germany is anticipated to face challenges throughout 2024 as does France. Furthermore, both economies grapple with rising inflation in the services sector and surprisingly, despite the Red Sea tensions, the manufacturing sector continues to note price declines.

Our perspective is that the repercussions of tensions in the Red Sea will manifest with a somewhat delayed impact on prices within the manufacturing sector and the effects will affect the economy with lag. The manufacturing sector will be the drag on the European economy in the first half of the year.
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