EU Economy: Weekly Commentary – 15 April, 2024
European Market Review

European bond yields saw a decline following Lagarde's dovish remarks, leading to a widening spread between Bund and US bonds. European stock performance was mixed. The EUR/USD pair experienced a decline after the ECB announcement. Brent oil prices remained above $90.

European bond yields declined this week, buoyed by Lagarde's dovish meeting and inflation data. The spread widened as 10-year US government bond yields are now 215 bp over German Bunds, reaching the widest level since 2019. Divergent monetary policies, along with lower inflation rates, contributed to this gap. European stock markets displayed a mixed performance, with the PSI 20 rising nearly 2% and the FTSE 100 climbing more than 1%. The EUR/USD pair dropped to 1.0643 following the ECB meeting. Furthermore, Brent oil remained above $90 per barrel throughout the week.
Europe View Synopsis
The ECB suggests a potential rate cut in June amidst concerns over inflation. German industry exhibits signs of growth, while the UK economy rebounds.

The ECB has signaled a potential rate cut in June, citing weakening inflationary pressures and economic conditions. Recent German industrial data suggests a possible end to stagnation, with modest growth observed. Meanwhile, the UK economy is experiencing a rebound, buoyed by strong performances in manufacturing and services. Despite these positive developments, concerns regarding inflationary pressures linger, affecting the trajectory of economic recovery. While we anticipate cuts in June, we don't foresee them being as aggressive as the market expects.
ECB meeting
The ECB has officially signalled the possibility of a rate cut in June.

The ECB has opted to maintain its current policy interest rates, yet it has hinted at the prospect of a rate cut in June. The decision comes amidst a backdrop of diminishing inflationary pressures, prompting the ECB to clearly outline its future course of action. For the first time, a few members were confident enough to start cutting rates.

Over recent months, the ECB has gradually shifted its communication stance from a more assertive outlook to a more accommodative one. The accelerated decline in headline inflation and low economic growth have opened the way for rate cuts, albeit not a complete reversal of the hikes implemented since July 2022, but rather a measured relaxation of the stringent stance. Cut rates soon have some problems, particularly with the euro, which reduces its value and import prices could increase.

Despite speculation among some market participants regarding aggressive rate cuts in the coming months, recent US inflation data serves as a cautionary reminder to the ECB about the risks associated with reflation. Lagarde emphasized the ECB's independence from the Fed, indicating that they make decisions autonomously. Elevated services inflation, alongside surging oil prices and wage trends, highlights the possibility of an inflationary resurgence in the Eurozone, albeit not to the same extent as in the US. Additionally, structural impediments such as labor shortages and capacity constraints resulting from insufficient investment, as well as reliance on energy and commodities, pose risks of inflation outpacing economic recovery efforts. We do not anticipate aggressive rate cuts in the near future. Our perspective suggests three rate cuts.
Industry in Germany
German industrial data suggests an end to the stagnation observed in Q1. Despite sentiment indicators remaining low since late last summer, recent industrial figures provide a glimmer of hope.

Industrial data saw a 2.1% MoM increase in February, marking the second consecutive monthly rise. However, industrial production remained down by 4.9% YoY, with improvements across most sectors except for energy production. The construction sector notably surged by almost 8% MoM, benefiting from favourable winter conditions and advancements in the real estate sector.

Exports saw a slight decline in February compared to January, with imports increasing, narrowing the trade balance, it's important to note that these figures are not adjusted for inflation. Year-on-year, exports decreased by over 5%, while imports dropped by nearly 9%. The current uptick in the German industry reflects a cyclical recovery rather than a structural one, as industrial production still lags behind pre-pandemic levels by approximately 8%. Noteworthy shifts in global trade patterns and geopolitical tensions also impact German exports, with a notable increase in exports to the US and a decline in exports to China.

Industrial data offers some relief, yet it does not signal a substantial recovery at this stage. Challenges such as global supply chain shifts and policy uncertainty continue to persist. Our perspective indicates stagnation in the first half of the year, with the potential for recovery in the second half, particularly when the ECB begins to implement rate cuts. We do not anticipate significant inflation rebounds, which could affect the manufacturing sector.
The UK economy is rebounding with consecutive months of growth, propelled by strong performances in both manufacturing and services sectors. This trend indicates a probable expansion in 2024.

The UK economy is rebounding, with a couple of consecutive months of growth indicating a positive outlook for 2024. Strong manufacturing performance contributed to a 0.1% GDP increase in February, following a rebound from a sluggish December. Particularly, industrial production increased by 1.1% MoM. Positive trends in the service sector, coupled with sustained real wage growth, are expected to support further expansion throughout the year. Although past rate hikes continue to influence the economy, their impact on mortgage holders is expected to diminish by summer. Growth rates are anticipated to remain positive, with momentum in H2 of the year.

Our perspective does not indicate a likelihood of rate cuts in the near future. We anticipate further inflationary pressures, particularly in the shelter sector. A recovery is not expected until the end of the year, as the economy appears to be experiencing a flat year.
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