EU Economy: Weekly Commentary – 24 June, 2024
European Market Review
European bond yields and stock markets rose amid political tensions, inflation, euro depreciation, and higher Brent crude oil prices.

European bond yields increased during a week marked by escalating political tensions, notably in France, and rising inflation. The credit spread between German and French bonds continued to widen, reaching its largest gap since the European debt crisis. Stock markets exhibited a positive trend, with gains across all major European exchanges. The euro depreciated to 1.0691 against the dollar. Additionally, Brent crude oil prices rose by 2.84%, driven by projections of higher summer demand anticipated to reduce inventories.
Europe View Synopsis
Euro area inflation rose to 2.6%, which could lead the ECB to consider pausing rate cuts. Germany's economic sentiment improved slightly, but business activity slowed. The BoE held rates at 5.25%, awaiting further inflation data before cutting rates.

Euro area inflation rose to 2.6% YoY, up from 2.4% in April, marking the first increase since December 2023. The core CPI also climbed to 2.9% from 2.7%. The key contributor was services. This rise suggests the ECB may pause further interest rate cuts, awaiting Fed actions. Concurrently, Germany's ZEW economic sentiment slightly improved, but business activity in the Eurozone slowed, with lower PMI figures indicating potential economic challenges. In the UK, the BoE held rates at 5.25%, reflecting caution despite hitting the 2% inflation target, with markets anticipating possible rate cuts pending future inflation data.
Euro area inflation rose in May, marking its first increase since December 2023. European Central Bank (ECB) may pause rate cuts pending Fed actions.

The inflation rate in the euro area increased to 2.6% YoY in May from 2.4% in April, marking the first uptick since December 2023 and reaching its highest level since February of that year. Concurrently, the core consumer price index (CPI) rose to 2.9% YoY from 2.7% in the previous month. Services contributed the most to the annual inflation rate (1.83 percentage points (pp)), followed by food, alcohol, and tobacco (0.51 pp), non-energy industrial goods (0.18 pp), and energy (0.04 pp).

These figures suggest that the ECB is likely to withhold further interest rate cuts until the end of the year, pending developments from the Federal Reserve. The ECB's objective should be to prevent currency depreciation and declines in European bond yields. We do not expect cut rates until the end of the year.
Consumer Sentiment
Germany's ZEW economic sentiment rose slightly to 47.5 points, while the assessment of its economic situation declined to -73.8 points. Euro area sentiment improved to 51.3, above expectations, with a stable current situation index. Persistent stagnation reflects ongoing economic challenges, exacerbated by rising inflation expectations.

The ZEW economic sentiment indicator for Germany showed minimal changes in the latest June 2024 survey, with an increase to 47.5 points, up by 0.4 points from May. Conversely, Germany's assessment of its economic situation slightly worsened, with the corresponding indicator decreasing by 1.5 points to -73.8 points. In the euro area, the ZEW economic sentiment improved from 47.0 to 51.3, surpassing expectations of 47.2. The current situation index remained stable at -38.6. Recent developments underscore persistent stagnation in both sentiment and situation indicators. Moreover, respondents' inflation expectations have risen, likely influenced by May's inflation rate surpassing initial forecasts.

Germany continues to endure economic challenges, and we do not foresee a swift recovery. Similarly, across the EU, we do not anticipate improvements in consumer sentiment, as minor inflationary pressures expected throughout the year are likely to impact consumers negatively.
Business Activity
Eurozone's economic recovery slowed with lower PMI figures and Germany's manufacturing sector facing significant declines. Despite setbacks and ongoing risks, moderate growth is still expected in the second half of the year.

The Eurozone's economic recovery faced a reality check with lower PMI figures suggesting second-quarter growth may fall short of initial expectations. Germany, where economic recovery lost momentum amid concerns over the French elections, saw business activity unexpectedly decline, particularly in manufacturing, which recorded its worst month since February. The German Composite PMI fell sharply to 50.6, contrasting with expectations of a rise to 52.7. Manufacturing PMI plunged to 43.4, deepening into contraction territory and highlighting significant challenges ahead for the region's largest economy. The broader Eurozone also experienced a decline in the composite index from 52.2 to 50.8, indicating a slowdown compared to the robust first-quarter expansion. Despite these setbacks, the overall PMI of 50.8 still points to modest growth, supported by easing inflation pressures, which could pave the way for further ECB rate cuts this year.

While recent months have shown improved business sentiment and GDP growth exceeding expectations in the first quarter, the June PMI figures underscore a more cautious economic outlook for 2024. This signals a departure from earlier optimism of a quicker recovery, highlighting ongoing challenges such as lingering Eurozone risks and the impact of higher interest rates.

Despite these headwinds, we still anticipate moderate growth in H2 of the year, supported by improving consumer purchasing power and somewhat favourable financial conditions.
United Kingdom
The Bank of England (BoE) holds rates steady at 5.25%, despite hitting the 2% inflation target. Services inflation rises, suggesting a cautious approach to future rate cuts. Markets anticipate a 60% chance of a cut next month amid economic uncertainties, awaiting the July inflation report for further policy clues.

Despite favourable inflation data hitting the 2% target, the BoE's decision to keep rates at 5.25% this month, despite recent increases in services inflation, signals a cautious approach tempered by indications of potential rate cuts ahead. The statement and minutes reveal a nuanced perspective, attributing the inflation spikes to temporary factors rather than a fundamental shift. Market sentiment has responded with a 60% probability priced in for a cut next month, reflecting increasing investor anticipation consistent with Governor Andrew Bailey's earlier hints of potentially deeper cuts than previously anticipated. As the Bank navigates economic uncertainties, upcoming data releases, particularly the mid-July inflation report, are expected to play a crucial role in determining the timing and extent of future monetary policy adjustments.

UK services inflation has once again surpassed expectations, largely due to transient factors, and is unlikely to significantly affect the Bank of England's confidence in its inflation forecasts. Recent data indicates that food, household goods, and clothing are contributing less to inflation compared to previous months, helping UK headline inflation return to the 2% target for the first time since spring 2021. While disinflationary trends are slowing the negative impact of household energy bills is expected to decrease going forward.

For the BoE, the focus remains on services inflation, which has exceeded expectations for the second consecutive month. This increase, driven in part by noise factors such as higher airfares and package holiday prices, suggests the BoE is likely to maintain rates at their current levels in the short term.

We expect inflation to remain around 2% for the rest of the year, with possible spikes pushing inflation higher by year-end as the first effects of premature rate cuts begin to affect the economy.
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