EU Economy: Weekly Commentary – 22 April, 2024
European Market Review
European bond yields climbed on strong German PPI data. Stocks declined with the exception of Spain and Italy. EUR/USD reached 1.0658. Brent oil fell to $85 despite escalating Middle East tensions.

European bond yields rose in response to robust German Producer Price Index (PPI) data, indicating increased inflationary pressures. This led to a decline in stock markets overall, with the exception of Spain and Italy, where investors sought higher returns (thanks to dividends and share buybacks) amid relatively low valuations compared to the rest of European markets. The EUR/USD exchange rate reached 1.0658, reflecting fluctuating market sentiment and economic indicators. Despite escalating tensions in the Middle East, Brent oil prices fell to $85 per barrel, suggesting concerns about global demand and supply dynamics in the energy market.
Europe View Synopsis
Eurozone inflation stabilizes, ECB considers rate cuts. Germany's investor confidence rises. UK struggles with 6% services inflation.

In the Eurozone and the EU, inflation stabilized, prompting the European Central Bank (ECB) to contemplate rate cuts in June. This decision comes amid persistent services inflation at 4%, signalling ongoing price pressures in the sector. Eurozone industrial production exhibited a modest increase in February, though concerns regarding economic outlook persist. Meanwhile, investor confidence surged in Germany, indicating growing optimism about the country's economic prospects.

On the other hand, the United Kingdom is grappling with 6% services inflation, which has led to delays in anticipated rate cuts. The higher-than-expected inflationary pressures in the services sector have prompted policymakers to reassess their monetary policy stance, balancing the need to support economic growth with the imperative to contain inflationary risks.
In March 2024, inflation within the Eurozone and the European Union stabilized. However, services inflation remains stubbornly high at 4%. Market is expecting ECB to consider a rate cut in June.

The inflation rate within the eurozone has stabilized at 2.4% year-over-year (YoY), aligning closely with the 28-month low observed in November and nearing the European Central Bank's (ECB) target of 2%. Additionally, core Consumer Price Index (CPI) has also decreased to 2.9%. Across the European Union, overall annual inflation moderated to 2.6% in March, with core CPI reducing to 3.3%. Of particular concern are the persistent inflationary pressures within the services sector, which have remained elevated at 4%.

With this data, the ECB could be poised to initiate interest rate reductions. ECB President Christine Lagarde has signalled the likelihood of cuts, with June emerging as a focal point for market attention. This suggests that the ECB may take measures to stimulate economic activity and address inflationary pressures within the eurozone, as part of its mandate to maintain price stability and support sustainable economic growth.

We anticipate a sustained decrease in inflation across Europe in the coming months. Several factors contribute to this trend, including subdued energy demand, economic fragility, elevated interest rates, and stagnant wage growth. While minor fluctuations may occur periodically, we expect them to be insufficient to disrupt the overall downward trajectory of inflation.

Aligned with market expectations, we predict that the European Central Bank (ECB) will implement rate cuts in June. This proactive measure is aimed at addressing economic challenges and supporting stability within the EU.
Industrial production
Eurozone industrial production showed a slight rise in February, but manufacturing concerns persist, signalling ongoing challenges in the sector.

Eurozone industrial production experienced a modest uptick of 0.8% in February, following a notable decline in the previous month. However, this marginal improvement does little to alter the ongoing downward trend in production, especially within the manufacturing sector, which remains a significant concern for the eurozone economy, particularly in Germany. Despite sporadic signs of progress, such as consecutive monthly growth in Germany and Spain, overall production figures continue to disappoint.

The February increase was primarily driven by gains in capital, intermediate, and durable goods production, while energy and non-durable consumer goods witnessed declines. Unfortunately, we do not anticipate significant improvements in the near term. The recent uptick in production is insufficient to offset losses from earlier in the quarter, indicating that the eurozone's industrial sector will face continued challenges in the first half of the year.

Our perspective suggests that a recovery may materialize towards the end of the year when the effects of policy adjustments start to positively impact the economy. However, until then, the industrial sector is likely to remain under pressure, requiring careful monitoring and strategic interventions to support growth and stability.
Investor confidence in Germany rose significantly this month, with the ZEW indicator climbing to 42.9, driven by improving economic sentiment.

Investor confidence in Germany experienced a significant improvement this month, as indicated by the latest ZEW economic sentiment indicator. The index surged to 42.9, marking an impressive increase of 11.2 points from March. Moreover, the assessment of the current economic situation in Germany witnessed a modest rebound, rising by 1.3 points to -79.2. Across the eurozone, the ZEW indicator of economic sentiment also climbed by 10.4 points to 43.9 in April, reaching its highest level since February 2022.

Achim Wambach, president of the ZEW economic institute, attributed the heightened optimism to a recovering global economy. Half of the respondents anticipate a rebound in the German economy over the next six months. Additionally, better assessments of the economic situation and improved expectations regarding Germany's export destinations further contributed to the positive outlook.

While there are signs of a recovery, economic growth remains challenging. We anticipate modest expansion in the EU economy overall; however, we foresee a period of stagnation specifically in Germany. Despite the positive sentiment, uncertainties and obstacles persist, necessitating continued vigilance and strategic policymaking to foster sustainable growth and resilience in the region.
UK inflation
UK services inflation at 6% presents a challenge to BOE’s monetary policy with an expected rate cut delayed. Whilst inflation overall fell to 3.2% due to the food prices, persistent rental inflation and wages complicate decision-making.

The recent release of UK services inflation data, reaching 6%, presents a significant challenge for the Bank of England's monetary policy framework. Initial expectations for a rate cut in either May or June have been revised due to the persistent nature of services inflation. Now, indications suggest that the first reduction in interest rates may not occur until November. Despite the overall UK inflation rate dropping to 3.2% year-over-year, its lowest level since September 2021, attributed primarily to a slowdown in food inflation.

While wage growth has surpassed expectations, the resilience of services inflation, particularly driven by rental inflation remaining at 6.0%, highlights the complexities facing policymakers. Consumers can anticipate further disinflation in utility bills, with an average decline of 12% in April, as well as in food prices, currently at 4% compared to nearly 20% a year earlier. These dynamics paint a nuanced economic landscape, requiring careful consideration by policymakers as they navigate future monetary policy decisions.

We do not anticipate cuts until at second half of the year. Inflation remains significantly above the target, and concerns regarding services inflation and sticky wages at 6% underscore the need for the Bank of England to adopt a cautious approach.
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