European bond yields rose, stock markets fell, and Brent crude oil prices dropped amid geopolitical tensions and weak demand.

European bond yields rose across the board. Short-term yields, which are highly sensitive to expectations regarding the ECB monetary policy, rebounded after reaching their lowest point in almost two years. Stock markets reacted negatively, with all major indices posting losses. This decline occurred despite a positive week for macroeconomic data. The euro remained under pressure against the dollar, trading at 1.0977. In the commodities market, Brent crude oil prices dropped over 8.5% due to escalating geopolitical tensions in the Middle East, rising inventories, and sluggish demand.

Eurozone inflation has decreased to 1.8%, yet ongoing economic weakness and reduced business activity may lead the ECB to implement a total of 75 bp in rate cuts over three meetings in the final quarter.

Eurozone inflation fell to 1.8%, with core inflation moderating to 2.7%, primarily driven by a 6% drop in energy prices. Despite this encouraging trend, services inflation remains elevated at 4%. In Germany, inflation declined to 1.6%, its lowest level since January 2021, bolstered by substantial reductions in petrol and electricity costs. However, ongoing economic weakness is resulting in a decrease in job vacancies, potentially leading to a slight rebound in the unemployment rate, currently at a record low of 6.4%. Business activity in the Eurozone contracted in September, as reflected by the HCOB Composite PMI falling to 49.6, signalling weakening demand and job cuts. Given these dynamics, we expect the ECB to implement a 75-basis point rate cut in the final quarter 2024 to stimulate recovery.

Eurozone inflation fell to 1.8% in September, while German inflation dropped to 1.6%, driven by lower energy prices. With growth slowing, the ECB faces balancing inflation risks and economic stagnation concerns.

Eurozone inflation dropped to 1.8% in September, with core inflation easing to 2.7%, edging closer to the ECB’s 2% target. However, services inflation remains elevated at 4%. Despite ECB President Christine Lagarde’s cautious stance, the decline surpassed most forecasts, driven largely by a 6% drop in energy prices. Recent data show slowing growth and reduced business price expectations, shifting the ECB’s focus from inflation to concerns over economic stagnation. With inflationary pressures easing and growth faltering, the October meeting will be pivotal for deciding on policy adjustments to support recovery.

In Germany, headline inflation fell sharply to 1.6% in September from 1.9% in August, marking the lowest level since January 2021. This decline was led by a 15% drop in gasoline prices and a 25% reduction in electricity costs year-on-year. The disinflationary trend appears broad-based, as prices for education, communications, and services also declined month-on-month. While inflation may stabilize, structural factors like demographic changes and deglobalization could pose future price risks, complicating the ECB’s decision-making as calls for rate cuts grow amid slowing German growth.

Given the recent inflation and growth data, we now anticipate more ECB rate cuts than previously expected. We foresee the ECB cutting rates by a total of 75 basis points in October, November, and December, which could weaken the euro if the Federal Reserve does not reduce rates as aggressively.

The Eurozone’s unemployment rate remains at a historic low, despite economic weakening, but declining vacancies may lead to a slight increase soon.

The Eurozone’s unemployment rate stood at 6.4% in August, unchanged from July and still at a historic low since the currency bloc's inception in 1999, despite a weakening economy. While labour demand remains strong, sustaining household income growth and confidence, job vacancies are declining, with the vacancy rate dropping to 2.6% from 2.9% in the first quarter. Businesses continue to cite labour shortages as a key issue, which has so far kept unemployment low despite economic sluggishness. However, with faltering economic growth, increasing bankruptcies, and a reduction in job vacancies, a slight uptick in unemployment is expected, though the rise will likely be limited given the continued demand for workers.

We anticipate a modest rise in unemployment in the final quarter, fuelled by persistent economic weakness, particularly in manufacturing, and the typical drop in seasonal employment following the end of the summer period.

The Eurozone economy contracted in September, with the HCOB PMI falling to 49.6. Germany, France, and Italy recorded simultaneous declines, while Spain grew sharply. Weaker demand and job cuts intensified.

The Eurozone economy experienced a downturn in September 2024, with the Composite PMI Output Index declining from 51.0 in August to 49.6, indicating a mild contraction in overall business activity for the first time since February. Notably, Germany, France, and Italy all recorded simultaneous contractions—the first occurrence in 2024—with Germany at 47.5, France at 48.6, and Italy at 49.7. Meanwhile, Spain and Ireland posted expansions, reaching 56.3 and 52.1, respectively. Demand for goods and services fell at the sharpest rate in eight months, driving reductions in order backlogs and a marginal increase in job cuts. Employment levels fell at the joint-fastest pace since December 2020. Meanwhile, cost pressures moderated significantly, with input price inflation at a 14-month low and output charges rising at the slowest pace in three-and-a-half years. Manufacturing output recorded its steepest decline year-to-date, while services growth slowed to a 7-month low. Weakening new business volumes, exacerbated by the sharpest fall in export sales since December 2022, contributed to further demand deterioration. Business confidence softened, falling below its historical average. With sentiment subdued and only marginal growth anticipated in the third quarter, economic stagnation is likely to persist into Q4 2024.

Given the current economic landscape—marked by a weakening economy, decreasing inflation, and persistently low employment levels—while a modest rebound is anticipated, we expect the ECB to implement a 75 bp interest rate cut in the final quarter of 2024.