EU Economy: Weekly Commentary – 22 July, 2024
European Market Review
European bond yields fell on political uncertainty and economic concerns. The market anticipates an ECB rate cut. Stock markets declined, the euro stable, and Brent crude dropped over 3%.

European bond yields declined throughout the week due to political uncertainty, decreasing inflation, and a deteriorating economic outlook. This environment has increased the likelihood that the European Central Bank (ECB) will cut interest rates again in September, with the market pricing in an 80% probability of this occurrence. The yield spread between French and German benchmark bonds narrowed by 66.3 basis points over the week. Despite favourable inflation data, major European stock markets, excluding Portugal, experienced declines. The euro remained relatively stable against the dollar at 1.0890. Brent crude oil prices dropped by over 3%, driven by concerns of weaker-than-expected demand.
Europe View Synopsis
The ECB has kept interest rates at 4.25% and provided no guidance, reflecting caution amid mixed data. Inflation remains high, industrial production is declining, and consumer sentiment is weak. Rate cuts are expected.

The ECB has decided to keep its benchmark interest rate at 4.25% and has not provided forward guidance, reflecting a cautious stance in light of mixed economic data. The Eurozone’s inflation rate has decreased slightly to 2.5%, but core and services inflation remains elevated and sticky. Industrial production fell by 0.6% in May, continuing a decline that began in September 2022, and consumer sentiment has weakened, particularly in Germany. Given these conditions, the ECB is anticipated to implement rate cuts in September and December to bolster economic growth. However, the current economic landscape remains challenging, with persistent inflationary pressures and weak industrial output influencing the growth outlook.
Interest Rates Decision
The ECB has kept rates unchanged and offered no forward guidance, reflecting a cautious stance amid mixed economic data.

The ECB has decided to maintain its current benchmark interest rate at 4.25%, without providing further guidance on future monetary policy. This decision reflects the ECB's cautious approach, continuing to base its actions primarily on data trends, particularly wages—which are still rising—and inflation in the services sector. ECB President Christine Lagarde indicated that overall inflation is expected to remain above the target for an extended period into the next year. No new signals have been given regarding the trajectory of future monetary policy.

Recent economic indicators suggest weaker growth prospects for the upcoming quarter and a decrease in headline inflation, though core and services inflation remain high. The drop in confidence indicators in June, coupled with disappointing data from May, points to a slowing economic recovery in the Eurozone. Given this information and the forthcoming data over the summer, a rate cut by the ECB in September is anticipated, coinciding with a potential rate cut by the Fed.

We regard this decision as appropriate and aligned with market expectations. The ECB must exercise prudence to ensure the stability of the euro and bond yields. We anticipate two rate cuts for the remainder of the year: one in September and another in December.
Inflation
Eurozone inflation is 2.5%, down from May. Core inflation and services remain high, but energy and food prices fall.

In June 2024, the annual inflation rate in the Eurozone was 2.5%, a slight decrease from 2.6% in May. While this figure is favourable, concerns persist regarding core inflation and services inflation, which remain at 2.9% and 4.1%, respectively. Energy and food prices continue to decline, but services remain the primary driver of overall inflation. Notably, several countries have reported inflation rates below 2%, with Finland and Italy experiencing particularly significant reductions, now at 0.5% and 0.9%, respectively.

We anticipate that inflation will continue its trajectory towards the target, although achieving this goal may be delayed somewhat by persistent inflationary pressures in the services sector.
Industrial Production
Eurozone industrial production fell by 0.6% in May, continuing a decline since September 2022, with no recovery in sight.

Eurozone industrial production experienced a further decline of 0.6% compared to April, continuing the downward trend that began in September 2022. This marks the first reduction since January, leaving production levels slightly below those seen at the start of the year. Germany and France led the decline with respective drops of 2.4% and 2.1%, while Spain and the Netherlands saw smaller decreases, and Italy experienced a minor uptick. Despite previous signs of stabilisation, the overall demand for goods remains weak, and the global economy is not yet robust, keeping Eurozone manufacturing in a precarious position. Survey data indicate that new orders are still sluggish, inventories remain high, and capacity utilisation continues to fall. Although there is potential for a turnaround in the second half of the year if consumer spending increases due to real wage growth and lower rates, there is currently little evidence to suggest an imminent recovery, highlighting the challenges facing the Eurozone's economic growth.

We do not expect significant improvements until the ECB lowers interest rates. The sector is expected to be the drag on EU economic growth this year.
Consumer Sentiment
Germany's ZEW Economic Sentiment fell, the current situation slightly improved. Eurozone sentiment also declined in July.

ZEW Indicator of Economic Sentiment for Germany declined for the first time since July 2023, registering 41.8 points, down 5.7 points from June. Conversely, the assessment of Germany's current economic situation saw a slight improvement, with the corresponding indicator rising by 4.9 points to minus 68.9 points. ZEW President Professor Achim Wambach attributed the downturn in economic expectations to a variety of factors, including lower-than-anticipated German exports in May, political uncertainty in France, and uncertainty surrounding future monetary policy by the ECB. Similarly, sentiment among financial market experts regarding the economic prospects of the Eurozone declined in July, with the indicator falling to 43.7 points, a decrease of 7.6 points from June, while the situation indicator for the Eurozone edged up by 2.5 points to minus 36.1 points.

We anticipate that consumer sentiment in the Eurozone, particularly in Germany, may decline further due to persistent high inflation and elevated interest rates. However, we foresee a gradual improvement towards the end of the year, following the anticipated rate cut by the ECB in September.
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