EU Economy: Weekly Commentary – 12 February, 2024
Eurozone View Synopsis
Inflation picked up in January, remaining sticky in services but manufacturing costs increases (future increases for consumers). No cut rates until the second half of the year.

The European Central Bank is looking to cut rates in the second half of the year. The decision for the ECB is difficult because whilst the economy (especially Germany) is struggling, inflation showed a rebound during January. Of note, consumer spending dropped during December and German industrial sector is still suffering.
Business activity
The Eurozone economy suggested early indications of recovery during January. Growing inflationary pressures boosted the European Central Bank's case for holding interest rates steady at their current record highs.

The Eurozone composite PMI for January registered at 47.9, reflecting a 0.3% MoM increase and marking a six-month high. Although both the general PMI and Services PMI remain below the 50 thresholds, indicative of ongoing contraction in euro area business activity, the latest figures signal the slowest rate of decline since July of the previous year. The modest contraction in factory production mitigated the decline in overall output levels in January, counteracting a marginally faster deterioration in services activity. A notable spread in regional economic performance was evident at the country level. Southern Eurozone economies, notably Spain and Italy, experienced mild but noteworthy improvements in economic activity levels at the outset of 2024. These upturns marked the strongest for Spain in six months and Italy in eight months. In contrast, Germany and France witnessed a worsening of contractions, with the composite output index declining in both instances, albeit remaining above the lows observed in 2023.

Inflation in the Eurozone will show a rebound in January, with rates of input cost and output price inflation accelerating to eight-month highs. This acceleration was attributed to more pronounced price increases across the service sector. Geopolitical tensions in the Red Sea and challenges in the Panama Canal are expected to exert additional inflation pressure.

Our perspective points to more increases in inflation but the overall trend should be decreasing. The ECB won't cut rates until the second half of the year due to recent price hikes.
Consumer spending
Retail sales fell in December despite the holiday season highlighting the weakness of consumer consumption.

In 2023, retail sales experienced a decline of 1.8% both in the eurozone and the European Union. In December retail sales dropped by 1.1% in the eurozone and 1% in the European Union on a MoM basis. In annual terms, the reductions were 0.8% and 0.7%, respectively. The unexpected 1.8% MoM decrease in the food, drink, and tobacco category is noteworthy, particularly considering that the Christmas season traditionally sees boosted spending in this sector.

Looking forward to the first quarter of 2024, another contraction is anticipated. The impact of rising inflation is expected to influence consumer spending, with rates anticipated to remain elevated for more time than the market expects. The European Central Bank (ECB) faces a significant challenge as the economy grapples with stagflation or recession risk, while there is a simultaneous risk of inflation rebounding in the upcoming months, close to the current situation in the United States.

In our view, consumer spending could increase when the ECB cuts rates in the second half of the year. Until that date, retail sales may suffer the most. There is nothing to suggest otherwise.
Industrial sector
German industry remains stuck. Industrial production dropped again, ending the year 2023 at some 10% below pre-pandemic levels. Suffering longest-ever downturn, surpassing the 2008 financial crisis.

In December, industrial production experienced a notable downturn of 1.6% MoM, following a marginal decline of 0.2% in November. The broader trend throughout 2023 revealed a significant 3% contraction in industrial output, currently drifting more than 10% below pre-pandemic levels. This weakness is evident across multiple sectors, with the noteworthy exception of the automotive industry (historically strong).

The concerning data raises the risk of a downward revision in the Q4 GDP. Germany, in particular, faces severe challenges, ranging from strikes by train drivers, and airport and airline staff to disruptions in the supply chain due to the military conflict in the Red Sea and weather-related issues in the Panama Canal. As a consequence, the German economy is anticipated to undergo contraction in the first quarter of 2024.

Our economic outlook leans towards pessimism, expecting a stagnant economy throughout 2024. There is even a possibility of contraction in the first two quarters, particularly if the European Central Bank (ECB) does not opt to cut rates as a response to the current economic challenges.
German Inflation
Despite the increase in the price of CO2 and the volatility of energy prices, inflation overall fell. Germany's CPI has fallen to its lowest levels since 2021. Service inflation remains sticky.

German inflation in January dropped to 2.9%, down from December's 3.7%. This decrease was primarily driven by a significant decline in energy costs, which fell by -2.8% (4.1% Dec). Despite the discontinuation of brake energy prices and the introduction of higher carbon prices impacting fossil fuels such as motor fuels, heating oil, and natural gas, energy costs experienced a notable downturn. Food prices saw an increase of 3.8% in January, indicating a deceleration in the increases, although they still surpass the overall inflation rate (too high). Services inflation, however, remained persistent, rising by 3.4% in January (+0.2% in comparison with Dec).

The overall inflation trajectory is on a downward trend, but the final phase to the ECB target proves challenging to bring down, particularly with service prices remaining resistant.

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.