EU Economy: Weekly Commentary – 11 March, 2024
Europe View Synopsis
Rates remain unchanged but odds of a cut in June have increased. Economic growth was weak with Germany struggling.

The ECB held interest rates at current levels but is hinting at a possible June cut. Lagarde anticipates more data before signalling any rate adjustments. The central bank remains committed to its current stance, emphasizing its contribution to achieving the 2% inflation target. Germany's economic struggles continue, particularly in manufacturing, raising concerns for the wider EU. ECB's potential rate cuts in June are viewed as stimulating recovery in H2.
ECB interest rates
ECB keeps interest rates unchanged. June could see the first cut.

The ECB opted for a strategy of maintaining the status quo regarding official rates. The central bank resisted the temptation to send new signals about possible rate cuts, although Lagarde hinted that in June they would have more data. All policy rates remained unchanged and the overall tone of the policy statement did not change towards a more dovish stance. The ECB reiterated its commitment to maintaining current interest rate levels for an extended period, emphasizing the substantial contribution such a stance would make to achieving the goal of bringing inflation back to the 2% target.

Despite the worsening economic outlook and easing inflationary pressures, the ECB is refraining from rate cuts. Factors such as persistent underlying inflation, particularly in the services sector and uncertainties in wage developments contribute to the central bank's cautious stance. Any consideration of cutting rates could materialize at the June meeting, where sufficient data will be available to confirm whether the inflation scenario has truly stabilized or if there is renewed upward pressure on prices. This underlines the ECB's commitment to a prudent and data-dependent strategy to address the complex economic landscape.

Despite a consistent economic assessment, the latest projections revealed expected downward revisions to both growth and inflation forecasts. For the current year, ECB predict inflation rates of 2.3% in 2024, 2.0% in 2025 and 1.9% in 2026. Regarding economic growth, projections indicate that the euro area GDP growth of 0.6% in 2024, 1.5% in 2025 and 1.6% in 2026, which demonstrates a more optimistic perspective than some analysts maintain. The stagnation expected for 2024 is disinflationary. In addition, downward forecasts, it is aligned with rate cuts.

Our current thinking is for cuts to start in June. Germany is suffering more than expected and high rates are hindering any recovery. Germany could drag the EU economic growth during 2024 if the economy does not start to recover in the second half.
Economic growth
Low growth points to Europe being in stagflation. More data that the ECB needs to cut rates.

In Q4 2023, both the euro area and the EU maintained stable GDP, showing no change from the previous quarter but a slight annual increase of 0.1% and 0.2%, respectively. Employment in the euro area and the EU increased by 0.3%, with annual growth rates of 1.2% and 1.0%, respectively, for Q4 2023. Despite positive contributions from government expenditure and capital formation, negative impacts on GDP growth were observed due to changes in inventories and trade balances. Labour productivity declined by 1.1% in the euro area and 0.8% in the EU in Q4 2023 compared to the corresponding quarter of the previous year.
Business activity
Service prices increase hinders any rate cut in short term and causes inflation to persist.

Service providers experienced a modest uptick in business activity, offsetting a persistent decline in factory production. The ongoing downturn in demand, a key driver of the eurozone's economic contraction since mid-2023, showed signs of abating for the fourth consecutive month. This contributed to heightened growth expectations, reaching their peak in almost a year, and a renewed surge in job creation.

Despite the Eurozone Composite PMI remaining in contraction territory for the eighth consecutive month in February, there was a notable improvement. The index rose from 47.9 in January to 49.2, indicating a near-stabilization of the euro area economy. The services sector displayed a positive shift, with activity levels increasing for the first time since July 2023. However, the manufacturing sector, though experiencing a slowdown, continued to temper overall progress.

Economic performance varied significantly among the eurozone countries surveyed. Ireland and Spain witnessed solid expansions, with private sector business activity in Ireland reaching its fastest pace in a year and Spain's growth rate achieving a nine-month high. Italy also contributed positively, albeit with a milder expansion. Conversely, France and Germany, the two largest economies, remained sticky in contraction. While France's downturn showed signs of easing, Germany experienced its sharpest decline since last October.

The surge in prices, particularly in the service sector, has dissuaded the ECB from considering rate cuts. Input costs persisted, leading to an acceleration in the inflation rate, reaching its highest level in ten months. Both Eurozone goods and services experienced a notable increase in prices, marking the swiftest pace since last May.
From our perspective, Germany anticipates a stagnant year ahead, especially in manufacturing. The ECB's potential rate cuts are crucial for stimulating economic recovery in the second half of the year. We expect cuts in June.
Factory orders
German industry continues to suffer with no signs of a recovery.

At the outset of 2024, Germany contends with a significant 11.3% downturn in factory orders. This decline underscores the persistent challenges confronting Europe's largest economy in its efforts to overcome recent economic stagnation. The substantial drop is primarily linked to a significant decrease in electrical equipment orders, plummeting by 33.2%. Additionally, other transport equipment, encompassing aircraft, ships, and trains, faced a substantial downturn of 27.3%, while fabricated metal products experienced a 14.5% decrease. On an annual basis, the overall contraction amounts to 6%.

In January, industrial production experienced a favourable upswing, recording a 1.0% MoM increase compared to the -2.0% decline in December. Nevertheless, the YoY figures depict a persistent decline, with industrial production trailing by over 5%, now standing approximately 10% below pre-pandemic levels. Despite the positive 6.3% MoM surge in January exports, signalling a promising start to the year, caution is warranted.

We continue to maintain that German growth will lag other EU countries and we do not see a recovery for the economy in the short term.
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