EU Economy: Weekly Commentary – 13 May, 2024
European Market Review
European bond yields increased, except in the UK, with stock markets also rising. Market indices surged over 2.5% amid low trading volumes and scant macro data. EUR/USD rate remained stable. Brent crude prices unchanged despite positive trade data.

European bond yields rose across the board, except the UK. However, this movement did not influence the stock market, which also saw an increase. Notably, all market indices showed gains of over 2.5% for the week, largely driven by the absence of significant macroeconomic data and historically low trading volumes for the year. The EUR/USD exchange rate held steady at around 1.077, reflecting market sentiment and economic indicators. Meanwhile, Brent crude oil prices remained stable, despite being supported by favourable trade figures from China and a positive US jobs report.
Europe View Synopsis
Eurozone's service sector drives growth despite inflation. Germany's industry lags. UK sees GDP surge, signalling recovery.

The Eurozone's economy exhibits robust growth, driven by the service sector, despite escalating inflation. Spain leads with strong tourism and lenient policies, reflected in its high Services PMI. Germany's industrial sector struggles to recover, with March's industrial production halting after two months of growth, indicating persistent challenges and reliance on exports. Meanwhile, the UK sees a 0.6% GDP surge in Q1, signalling recovery from previous contractions, led by expanding services and production, although construction declines. Overall, the outlook is optimistic, yet challenges persist, including inflationary pressures and geopolitical tensions.
Business activity
Eurozone's economy grows strongly, led by the service sector, despite rising inflation. Spain outpaces its peers, aided by tourism and lenient policies.

The HCOB Eurozone Composite PMI indicates a robust expansion in the eurozone economy, with the Output Index hitting 51.7 and the Services PMI Business Activity Index reaching 53.3, both at 11-month highs. Led by the service sector, which saw solid output growth and the fastest job creation rate in ten months, the economy showed resilience despite intensifying inflationary pressures. All Eurozone countries experienced varying levels of business activity growth, with Spain leading, followed by Italy, Germany, and France. Despite challenges, optimism prevails for future activity levels. Additionally, the HCOB Eurozone Services PMI pointed to a strengthening service sector recovery, driven by increased demand and job creation, though business confidence dipped slightly. Rising inflationary pressures pose challenges, highlighting concerns about productivity and the ECB's cautious approach to rate cuts. Spain's strong performance is attributed to its robust Services PMI and less stringent government austerity measures, particularly beneficial for its tourism sector.

We anticipate overall improvements in Europe, yet foresee persistent inflation, particularly in services. Our perspective shows a rate cut by the ECB in June, in line with the market.
Germany's industrial production and exports
Despite the boost in first-quarter GDP growth from construction activity, German industry remains far from a recovery. We do note that exports played a positive role in Q1 GDP.

In March, industrial production in Germany came to a halt after two consecutive months of growth, showing a 0.4% decline compared to February's 1.7% increase. Year-on-year, industrial production remains more than 3% behind, with only slight improvements in investment goods production while other sectors witnessed declines. Notably, construction stood out with a 1% month-on-month increase, reinforcing its pivotal role in driving Germany's economic growth in the first quarter.

While recent positive economic indicators offered some relief, March's industrial production figures acted as a sobering reminder that achieving a robust recovery is neither immediate nor effortless. Demand for German industrial goods remains stagnant, with expected reductions in inventory and declining capacity utilization since the beginning of the conflict in Ukraine. Despite the end of the cyclical downturn and a resurgence of optimism, achieving a substantial recovery, especially in the industrial sector, presents a significant challenge.

March's trade data affirmed the resurgence of Germany's export-driven growth model, with exports rising by 0.9% MoM, leading to an expanded trade surplus. However, weak industrial orders suggest that the return to export-led growth may be short-lived. While net exports played a crucial role in first-quarter GDP growth, caution is warranted amidst shifting global trade dynamics and geopolitical uncertainties. Despite increased exports to the US, exports to China have decreased, highlighting the necessity for a more balanced economic strategy in Germany. Industrial orders further underscore the risk of relying too heavily on export-oriented growth, particularly with the ongoing weakness in demand for German manufactured goods since early 2022.

The halt in Germany's industrial production after two months of growth underscores the sluggish pace of recovery. Stagnant demand for industrial goods and geopolitical tensions emphasize the challenges ahead. We do not anticipate a recovery in the German economy until the end of the year, potentially affecting the trajectory of economic growth in Europe.

The German business model relied on cheap energy from Russia, affordable subcontractors in Eastern Europe, consistently growing exports to China, and lack of defence spending. While these pillars have vanished, Germany remains mentally entrenched in a world that no longer exists, which is affecting its industry.

The UK economy surged by 0.6% in Q1, rebounding after two quarters of contraction. Services and production expanded, but construction declined. Rising wages may lead the recovery being sustained.

The British economy has shown signs of resurgence, with a 0.6% increase in GDP in the first quarter. Following two consecutive quarters of decline, the economy entered a technical recession, with contractions of 0.3% and 0.1% in the fourth and third quarters of 2023, respectively. However, recent data indicates a favourable reversal, estimating a 0.2% growth in GDP compared to the same quarter a year earlier. Various sectors contributed to this growth, with services expanding by 0.7%, production by 0.8%, and construction experiencing a slight decline of 0.9%. Business investments increased by 0.9% during the quarter, though slightly lower than previous figures.

Despite fluctuations in the data, notably a significant drop in retail activity towards the end of the previous year, fully recovered in January. The overall trend suggests a strengthening economy. Forecasts predict sustained growth, driven by positive developments in real wage growth, eased mortgage pressures, and increased economic activity due to heightened migration levels.

The level of savings has sequentially increased, but when factoring in inflation, which diminishes wealth, savings in real bank accounts only marginally surpass pre-pandemic levels. The potential impact of savings on this year's growth remains uncertain, given their close correlation with consumption patterns. Additionally, while the ratio of job vacancies to unemployment has returned to pre-COVID levels and redundancies have been kept in check so far, there is a possibility of a gradual slowdown in the labour market. Early indications suggest that interest rate hikes may soon have a more pronounced impact on employment, hinting at a rise in layoffs and reduced spending.

As the British economy transitions towards improvement, the outlook for the second quarter appears increasingly optimistic. However, we anticipate that a substantial recovery may not materialize until the latter part of the year, as the effects of rate cuts begin to influence the economy.
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