EU Economy: Weekly Commentary – 18 March, 2024
Europe View Synopsis
With economic growth remaining weak, the ECB has decided to keep rates unchanged for now. However, there is an increasing likelihood of rate cuts in June. Germany's economic struggles further contribute to the uncertain outlook.
The beginning of the year saw a notable drop in industrial production, indicating potential economic challenges and signalling expectations for rate cuts by June. While Germany and Italy faced disinflationary pressures, France saw a slight rebound in February. In the UK, signs of economic recovery emerged in January, with cautious optimism for the year ahead amidst ongoing global uncertainties. ECB policymakers are divided on the timing and approach to rate cuts, with some favouring a June reduction while others suggest a more gradual easing strategy. We anticipate rate cuts in the second half of the year, as the European Central Bank (ECB) appears inclined to prioritize reducing inflation over preventing a recession.
The beginning of the year saw a notable drop in industrial production, indicating potential economic challenges and signalling expectations for rate cuts by June. While Germany and Italy faced disinflationary pressures, France saw a slight rebound in February. In the UK, signs of economic recovery emerged in January, with cautious optimism for the year ahead amidst ongoing global uncertainties. ECB policymakers are divided on the timing and approach to rate cuts, with some favouring a June reduction while others suggest a more gradual easing strategy. We anticipate rate cuts in the second half of the year, as the European Central Bank (ECB) appears inclined to prioritize reducing inflation over preventing a recession.
Industrial production
The drop in industrial production at the beginning of the year suggests that the overall economy may struggle to grow in the first half of the year. This development increases the likelihood of rate cuts in June or July, as policymakers may seek to bolster confidence and stimulate economic growth.
In January 2024, industrial production in the euro area experienced a notable decline of 3.2% compared to December 2023, while the EU saw a slightly smaller decrease of 2.1%. This drop was primarily driven by a significant decrease in capital goods production, which plummeted by 14.5% and 12.8% respectively. On an annual basis, the declines were even more pronounced, with a 6.7% decrease in the euro area and a 5.7% decrease in the EU. Notably, these declines followed a modest 1.6% increase in December, largely fuelled by Ireland, which has now marked a substantial decrease of almost 30%.
Despite recent upticks in survey data, there remains a lack of recovery in the fundamental manufacturing sector indicators. The ongoing challenges persist, particularly with high rates and energy prices, and we anticipate this trend to continue throughout the first half of the year.
The economic strain within the EU warrants consideration for rate reductions. However, the ECB's focus remains on controlling inflation to meet its target of 2%, prioritizing this over economic concerns. Without intervention, there is a risk of Europe slipping into recession this year. We maintain our expectation that rate cuts will commence in July, offering relief to the economy and offsetting the lower growth experienced in the first half of the year with improved conditions in the second half.
In January 2024, industrial production in the euro area experienced a notable decline of 3.2% compared to December 2023, while the EU saw a slightly smaller decrease of 2.1%. This drop was primarily driven by a significant decrease in capital goods production, which plummeted by 14.5% and 12.8% respectively. On an annual basis, the declines were even more pronounced, with a 6.7% decrease in the euro area and a 5.7% decrease in the EU. Notably, these declines followed a modest 1.6% increase in December, largely fuelled by Ireland, which has now marked a substantial decrease of almost 30%.
Despite recent upticks in survey data, there remains a lack of recovery in the fundamental manufacturing sector indicators. The ongoing challenges persist, particularly with high rates and energy prices, and we anticipate this trend to continue throughout the first half of the year.
The economic strain within the EU warrants consideration for rate reductions. However, the ECB's focus remains on controlling inflation to meet its target of 2%, prioritizing this over economic concerns. Without intervention, there is a risk of Europe slipping into recession this year. We maintain our expectation that rate cuts will commence in July, offering relief to the economy and offsetting the lower growth experienced in the first half of the year with improved conditions in the second half.
Inflation
Germany and Italy are experiencing continued disinflationary pressures, whilst France bucked the trend with an uptick in inflation.
In February 2024, Germany's inflation rate eased to 2.5% YoY, driven by lower energy prices and slower food price hikes. Despite a rise in carbon prices, energy prices dropped by 2.4%, affecting household energy and fuels. Food prices increased by 0.9%. Excluding food and energy, inflation was at 3.1%, while core inflation reached 3.4%. Goods prices rose by 1.8%, notably in used cars and beverages but dropped for mobile phones and information equipment. Service prices increased by 3.4%, particularly in insurance and vehicle maintenance. Overall, Germany's inflation reflects a mixed picture, with energy and food prices driving the trend.
In Italy, the CPI rose by 0.1% monthly and 0.8% annually, driven by increases in food, industrial goods, and transport services, while energy and communication slowed down. Core inflation was 2.4%, and inflation excluding energy was 2.7%. Groceries and unprocessed food decreased by 0.1% monthly but increased by 3.7% annually.
France recorded an annual inflation rate of 3% in February, slightly lower than January's 3.1%. Despite notable price increases, the moderation was partly due to base effects. Food and manufactured product prices rose by 1.7% and 0.8%, respectively, while energy and tobacco saw sharp increases.
Inflation is declining on an annual basis (lower pace, last mile), with some countries like Italy already below the 2% mark. With this trend, we expect rate cuts in the H2 likely before any cuts are seen in the United States.
In February 2024, Germany's inflation rate eased to 2.5% YoY, driven by lower energy prices and slower food price hikes. Despite a rise in carbon prices, energy prices dropped by 2.4%, affecting household energy and fuels. Food prices increased by 0.9%. Excluding food and energy, inflation was at 3.1%, while core inflation reached 3.4%. Goods prices rose by 1.8%, notably in used cars and beverages but dropped for mobile phones and information equipment. Service prices increased by 3.4%, particularly in insurance and vehicle maintenance. Overall, Germany's inflation reflects a mixed picture, with energy and food prices driving the trend.
In Italy, the CPI rose by 0.1% monthly and 0.8% annually, driven by increases in food, industrial goods, and transport services, while energy and communication slowed down. Core inflation was 2.4%, and inflation excluding energy was 2.7%. Groceries and unprocessed food decreased by 0.1% monthly but increased by 3.7% annually.
France recorded an annual inflation rate of 3% in February, slightly lower than January's 3.1%. Despite notable price increases, the moderation was partly due to base effects. Food and manufactured product prices rose by 1.7% and 0.8%, respectively, while energy and tobacco saw sharp increases.
Inflation is declining on an annual basis (lower pace, last mile), with some countries like Italy already below the 2% mark. With this trend, we expect rate cuts in the H2 likely before any cuts are seen in the United States.
ECB members
Divided timing to cut rates among the members.
European Central Bank (ECB) policymakers are divided on the timing and approach to potential rate cuts. Kazimir, known for his hawkish stance, advocates for a rate reduction in June but emphasizes the importance of awaiting further data to inform the decision-making process, cautioning against rushing the move and highlighting lingering inflationary risks. In contrast, Makhlouf, recognized for his dovish leanings, prefers a more gradual easing strategy, citing the nuanced nature of economic data and expressing scepticism towards significant individual rate cuts. Stournaras calls for an early start to rate cuts and proposes four cuts throughout 2024, while Knot anticipates a June rate reduction with potential further adjustments in September and December.
The majority of members are indicating a potential rate cut in June. However, we anticipate that the process may take longer than initially anticipated, with our target being September for the rate cut to materialize.
European Central Bank (ECB) policymakers are divided on the timing and approach to potential rate cuts. Kazimir, known for his hawkish stance, advocates for a rate reduction in June but emphasizes the importance of awaiting further data to inform the decision-making process, cautioning against rushing the move and highlighting lingering inflationary risks. In contrast, Makhlouf, recognized for his dovish leanings, prefers a more gradual easing strategy, citing the nuanced nature of economic data and expressing scepticism towards significant individual rate cuts. Stournaras calls for an early start to rate cuts and proposes four cuts throughout 2024, while Knot anticipates a June rate reduction with potential further adjustments in September and December.
The majority of members are indicating a potential rate cut in June. However, we anticipate that the process may take longer than initially anticipated, with our target being September for the rate cut to materialize.
UK growth
While there are small signals of recovery in the economy, the overall outlook remains weak.
The economic performance of the UK in January displayed indications of recovery; GDP increased by 0.2%. Despite recent fluctuations, notably within the manufacturing sector, which witnessed a stagnant output in January, there exists a prevailing sense of optimism regarding a gradual economic resurgence.
Forecasts for an improved consumer landscape in the UK are further reinforced by proposed rate reductions and the decline in wholesale gas prices, poised to yield a reduction in household energy expenditures. Prudent with the energy costs, given recent indications of price resurgence across Europe and the United States, particularly in gasoline. It is also crucial to monitor developments in the housing market and wage dynamics, the latter of which are exhibiting growth rates surpassing inflation.
The consensus among analysts points towards the first half of the year as the probable commencement period for the initiation of a monetary policy easing cycle.
The economic performance of the UK in January displayed indications of recovery; GDP increased by 0.2%. Despite recent fluctuations, notably within the manufacturing sector, which witnessed a stagnant output in January, there exists a prevailing sense of optimism regarding a gradual economic resurgence.
Forecasts for an improved consumer landscape in the UK are further reinforced by proposed rate reductions and the decline in wholesale gas prices, poised to yield a reduction in household energy expenditures. Prudent with the energy costs, given recent indications of price resurgence across Europe and the United States, particularly in gasoline. It is also crucial to monitor developments in the housing market and wage dynamics, the latter of which are exhibiting growth rates surpassing inflation.
The consensus among analysts points towards the first half of the year as the probable commencement period for the initiation of a monetary policy easing cycle.
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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.