EU Economy: Weekly Commentary – 10 June, 2024
European Market Review
European bond yields fell post-rate cut, stocks declined, the euro weakened to 1.0898 against the dollar, and Brent crude fell 2%.

Following the ECB rate cut, European bond yields declined, while stock markets exhibited negative trends, with most indices experiencing declines. The euro weakened to 1.0898 against the dollar. Additionally, Brent crude oil prices dropped by over 2% due to an ongoing period of oversupply.
Europe View Synopsis
The ECB cut interest rates by 25 basis points, signalling the start of an easing cycle. Q1 2024 saw modest GDP growth in the Eurozone and EU. Eurozone retail sales remain stagnant, while UK house prices show resilience.

The ECB cut interest rates by 25 basis points, signalling a potential easing cycle. Despite positive economic indicators, caution prevails, with a focus on inflation and US bond market influence. GDP in Q1 2024 for the Eurozone and EU rose by 0.3%, with varying performances across countries. Retail sales in the Eurozone saw a decline in April, indicating continued stagnation. Business activity accelerated in the Eurozone, driven by increased commercial activity and demand. The German labour market rebound is subdued, with unexpected increases in unemployment rates. German industrial production declined slightly in April, highlighting ongoing economic challenges. UK house prices experienced a slight monthly decline but yearly growth increased, supported by wage growth and economic optimism.
Interest rates decision
The ECB reduced interest rates by 25 basis points (bp), hinting at the start of a potential easing cycle. Despite positive economic indicators, a cautious approach is expected, with a focus on inflation and US bond market influence.

The ECB has announced a widely expected opportunistic proactive cut of 25bp in interest rates. Lagarde emphasized that this decrease doesn't necessarily mark the beginning of an easing cycle. Market expectations anticipate two more rate cuts this year as inflation is expected to head towards the ECB’s 2% inflation target.

The rate adjustment mirrors renewed policy makers faith in the ECB's forecasting abilities. The bank's latest projections, includes a slight upward adjustment in the 2025 inflation forecast to 2.2%. This strategic shift signals the ECB's intent to adopt a more forward-looking stance, moving away from relying solely on backward-looking data. However, this strategy isn't devoid of risks, as sustained inflationary and wage pressures could challenge the ECB's forecasts. While the current interest rate cut hints at a potential policy shift, the absence of explicit forward guidance introduces uncertainty about future rate adjustments. Clarity on the central bank's future monetary policy trajectory may emerge during the upcoming press conference, 18th July, led by ECB President Christine Lagarde.

The ECB seems inclined to bolster the recovery of the most industrialized nations, particularly Germany. Nonetheless, we anticipate the ECB to hold off on further interest rate cuts until after summer, opting for a cautious approach whilst monitoring economic developments to avoid premature optimism that could reignite inflationary pressures. Moreover, it's likely to postpone further cuts until after the initial Fed start to cut to prevent further euro depreciation. US bond relative value wield significant influence, and a large divergence between the two markets would result in more difficult investment environment for Europe. Consequently, substantial interest rate cuts are unfeasible for the ECB, as this could trigger a drop in European bond yields, prompting investors to favour US bonds with higher yields.
Economic growth
In Q1 2024, Eurozone and EU GDP rose by 0.3% compared to the previous quarter. Employment increased by 0.3%.

In Q1 of 2024, both the euro area and the EU witnessed a 0.3% uptick in GDP compared to the preceding quarter. This growth contrasts with a 0.1% dip in the euro area and stable performance in the EU during the fourth quarter of 2023. Furthermore, when compared to the same quarter of the previous year, seasonally adjusted GDP climbed by 0.4% in the euro area and by 0.5% in the EU.

Significant shifts in GDP components include a 0.2% rise in household final consumption expenditure, steady government final consumption expenditure in the euro area and a 0.1% rise in the EU, a notable 1.5% drop in gross fixed capital formation, and a 1.4% increase in exports in the euro area and a 1.0% rise in the EU, among others. Employment also experienced a 0.3% surge in both the euro area and the EU compared to the previous quarter, following a similar increase in the fourth quarter of 2023. Compared to the same quarter of the previous year, employment rose by 1.0% in the euro area and by 0.9% in the EU during the initial quarter of 2024. These statistics offer a coherent depiction of labour input alongside the output and income measures of national accounts.

Following the recent rate cuts by the ECB, we anticipate a bolstering of growth commencing in the latter half of 2024. Additionally, we do not anticipate further cuts until the year's end in December.
Consumer spending
Retail sales in the Eurozone experienced a downturn in April, underscoring the persisting lacklustre trajectory. Despite signs of modest recovery across much of the economy, the retail industry appears to be trailing behind, maintaining a stagnant pattern for now.

Following a promising performance in March, the retail sector faced another setback in April, with a 0.5% MoM decline in trade volume. This decline left the overall trade volume only marginally higher than February levels, indicating a continued trend of stagnation that commenced in 2023. With no meaningful recovery anticipated in the current quarter, it appears unlikely that Eurozone retail sales will exhibit significant improvement before the latter half of 2024. Despite recent gains in purchasing power among Eurozone consumers, particularly with wage growth outpacing inflation, the retail sector has yet to capitalise on this upward trend. While the consumption recovery has primarily favoured services in recent years, the timing of when retailers will benefit from the resurgence of real wages remains uncertain. Despite slight improvements in certain indicators, such as a modest uptick in order placements, overall sentiment remains subdued, with expectations for the coming months remaining pessimistic. Consequently, the outlook suggests that it will likely be the latter part of 2024 before any substantial improvements are observed in Eurozone retail sales.

We foresee retail sales continuing on their stagnant path until after the summer months. This can largely be attributed to consumer sentiment, which we anticipate will not see significant improvements, given the prevailing uncertainty regarding economic conditions within the Eurozone.
Business activity
The latest PMI report indicates accelerated growth in the Eurozone economy, primarily driven by heightened commercial activity and robust demand conditions. Despite inflation, job creation remains positive, with optimism for sustained growth in the coming months.

The last report from PMI indicates an upswing in the Eurozone economy, with growth reaching 52.2 in May compared to 51.7 in April, marking its most rapid pace in a year. This expansion has primarily stemmed from heightened commercial activity during May, bolstered by robust demand conditions, resulting in increased production and recruitment. Despite a moderation in inflation rates, they persist above pre-pandemic levels, underscoring the region's economic resilience. Spain leads the growth, trailed by Germany and Italy, while France experiences a slight setback.

The services sector has been pivotal in driving this growth, registering a substantial uptick in activity at 53.2, supported by a surge in new orders. Although the Manufacturing Sector Index for the Eurozone rose from 45.7 in April to 47.3 in May, it remains below the critical 50-point threshold denoting expansion. Nevertheless, this marks the sector's slowest decline in a year, hinting at a possible reversal in the longstanding downturn of the Eurozone’s manufacturing sector. Despite inflationary pressures, companies have efficiently managed their workload, sustaining a positive trajectory in job creation. Prospects appear optimistic, with heightened business confidence and forecasts of sustained growth in the second quarter. While France exhibits weaker performance, alignment with other Eurozone economies is anticipated in the upcoming months, ensuring continuous regional growth.

As composite PMIs across key Eurozone nations exhibit signs of improvement, confidence in the sector's ability to navigate uncertainties and foster sustainable growth in the future is mounting. We anticipate that with the rate cut, the manufacturing sector will edge closer to the expansion territory.
German labour market
The spring labour market rebound is subdued. Adjusted rates show unexpected increases, indicating a lag in economic response. Ongoing challenges persist.

The spring resurgence in the labour market appears subdued. Despite a further decrease in the number of unemployed individuals in May, the reduction was notably less pronounced than customary for this season. While the adjusted unemployment rate declined to 5.8%, accounting for seasonal variations revealed a surprisingly sharp increase of approximately 25,000 unemployed individuals, resulting in an unchanged unemployment rate of 5.9%. This discrepancy suggests a lag in the labour market's response to economic cycles, potentially elongating the process of regaining momentum. Recent indicators suggest a cautious uptick in the German economy. However, Federal Labour Office data for May showed a greater-than-expected increase in the number of unemployed individuals, underscoring the ongoing challenges in the labour market.

Unemployment may climb to 6%, yet we anticipate it will not surpass that threshold, given the potential for rate cuts to stimulate economic improvement.
German industry sector
In April, Germany's economy encountered declining industrial production, coupled with ongoing growth in exports.

This mixed performance underscores the sluggishness of the economic recovery. Despite optimism fuelled by first-quarter growth and improving confidence, the recent data reveal persistent weaknesses, including a drop in industrial production by 0.1% MoM and a 3.9% decrease YoY. While exports continued to rise, particularly in intermediate goods, the construction sector showed further weakening. Looking forward, the economy may see gradual improvement, supported by wage growth and potential cyclical factors. However, challenges such as geopolitical tensions and structural weaknesses persist, indicating a resilient yet uncertain path to recovery for Germany.

We expect that the European Central Bank's decision to cut interest rates will serve as a catalyst for initiating a gradual resurgence in the European economic powerhouse throughout the second half of the year.
UK housing market
UK house prices saw a slight monthly decline but a yearly growth increase, reaching an average of £288,688. Supported by wage growth and economic optimism, stability is expected despite potential impacts from Bank of England rate cuts.

The average house price in the UK experienced a slight decrease of 0.1% monthly, while the yearly rate of house price growth climbed to 1.5% last month, rising from 1.1% in April. Currently, the average house price stands at £288,688. Despite this, the market displayed resilience throughout the spring, buoyed by robust nominal wage growth and growing confidence in the economic future. With the macroeconomic landscape evolving and anticipated rate cuts from the Bank of England, we anticipate a period of relative stability in house prices, instilling confidence in both prospective buyers and sellers.

In the short term, we foresee minimal fluctuations in the housing market. However, we hold the belief that a rate cut could exert downward pressure on prices.
This commentary is for information purposes only and does not take into account the specific circumstances of any recipient. The information contained in this commentary does not constitute the provision of investment advice nor a recommendation, offer or solicitation to acquire (or dispose of) any financial instruments and/or services. Prior to making any investment decision investors should seek independent professional advice and draw their own conclusions regarding suitability of any transaction including the economic benefits and risks and legal, regulatory, credit, accounting and tax implications. The past performance of financial instruments is not indicative of future results and you may get back less than the amount you invested.

No representation or warranty, express or implied, is made by Dolfin Fund Management Ltd or any of its directors, officers or employees as to the accuracy, completeness or fairness of the information in this document and no responsibility or liability is accepted for any such information (save in respect of fraudulent representation or warranty).

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.