EU Economy: Weekly Commentary – 25 March, 2024
Europe View Synopsis
Inflation is steadily progressing towards the target. However, the manufacturing sector is anticipated to act as a constraint on overall economic growth.

Eurozone inflation moderated to 2.6%, with energy prices declining. The ECB may cut rates in June due to slowing wage growth and inflation trends. The Eurozone PMI rose to 49.9, driven by services, but challenges remain in manufacturing, notably in Germany and France. The ZEW Indicator for Germany surged to 31.7 points and business sentiment improved. We do not expect rate cuts in the next meeting, our target is June.
Inflation in the European Union (EU) is on a downward trend and is now nearing the target level. There is speculation that the European Central Bank (ECB) may consider cutting rates in June.

The inflation rate (CPI) in the euro area stood at 2.6% YoY in February 2024, marking the lowest rate observed in three months. While still above the European Central Bank's target of 2%, this figure suggests a slight moderation in inflationary pressures. Monthly CPI increased by 0.6% in February (vs -0.4% Jan). The core inflation rate stands at 3.1% (vs 3.3% Jan), marking its lowest level since March 2022.

Energy prices recorded a decline of 3.7% compared to January's -6.1%, while the rate of price growth moderated for food, alcohol, and tobacco (3.9% vs 5.6%) as well as for non-energy industrial goods (1.6% vs 2.0%). Conversely, service inflation remained stable at 4.0%, underscoring its resilience as a key component of overall inflation and one of the most followed data from the ECB. Another crucial factor for the ECB is wage growth, which, despite rising by 3.10% in the last quarter of 2023, experienced a slowdown compared to the 5.20% growth recorded in the previous quarter. Nonetheless, it continues to outpace inflation.

In Europe, inflation is declining at a faster pace than in the US, reflecting weaknesses in the economy. Currently, five countries in the EU are below the ECB's target of 2%. Given the inflation trend and economic challenges, there is speculation that the ECB may consider initiating rate cuts as early as June to stimulate growth in the H2.
Business activity
The increase in the Eurozone Purchasing Managers' Index (PMI) is viewed as a positive development. However, both Germany and France experienced a decline in the manufacturing sector.

The Eurozone economy displayed signs of potential stability, with the Composite PMI reaching 49.9, a 9-month high, driven mainly by the Services PMI hitting 51.1. However, the Manufacturing PMI dropped to 45.7, marking a 3-month low. New orders decreased, albeit at the slowest rate in ten months, and manufacturing output showed signs of slowing decline. Employment saw modest growth for the third consecutive month, with variations across countries; Germany and France experienced drops, while the rest of the region saw limited job creation, partly due to labour shortages. Supply chain issues eased slightly, and price pressures remained high, albeit with some easing.

Business activity is gradually improving, accompanied by rising optimism about the future. Yet, challenges persist in the manufacturing sector, with ongoing declines in new orders, although the pace of decline in production and new orders is moderating. The ECB's rate outlook hinges on wage growth and services inflation trends. While services inflation has risen recently, March's PMI suggests softening cost pressures and moderated output prices, indicating a pause in price acceleration, which could lead to a potential rate cut in June.

In general, the Eurozone economy grapples with challenges in the first quarter, yet signs of optimism are emerging. Although the economy remains fragile at present, we anticipate a more gradual recovery in the latter half of the year, largely driven by potential interest rate cuts expected in June.
German economy
There are indications that the German economy may begin to rebound in the second half of this year.

The ZEW Indicator of Economic Sentiment for Germany continued its upward trend, reaching 31.7 points (+11.8 points vs Feb 2023). There was minimal change in the assessment of Germany's current economic situation, with the corresponding indicator edging up by 1.2 points to reach minus 80.5 points.

ZEW President highlighted the notable improvement in economic expectations for Germany, with over 80% of respondents anticipating an interest rate reduction by the ECB within the next six months. This positive outlook is underpinned by factors such as anticipated growth in the German construction industry and the favourable impact on the export sector from improved economic prospects in China, along with the anticipated dollar depreciation against the euro.

Moreover, sentiment among financial market experts regarding the economic development of the Eurozone experienced a significant increase in March, rising to 33.5 points, representing an 8.5-point surge from February.

German business sentiment experienced a substantial uptick, rising to 87.8 from 85.7. While this increase offers some light at the end of the tunnel for the German economy, it's unlikely that these figures alone will be sufficient to avert another flat year for Europe's economic powerhouse. Despite the brighter outlook and a noticeable shift towards a more optimistic stance among businesses, caution is warranted as the economy grapples with ongoing challenges, particularly in the manufacturing sector, amid rising energy prices and elevated interest rates. The figure remains notably lower than previous summer levels.

Structural and cyclical challenges, including the need for economic reform and supply chain disruptions, continue to dampen economic activity. Once the ECB initiates rate cuts, Germany may begin to witness the recovery of its economy. From our perspective, this recovery could commence in the latter of the year. However, it's important to acknowledge that the recovery process in Germany will be gradual, given the depth of the economic downturn. We expect also a negative growth in this Q1.
Switzerland cut rates
While not a member of the EU, stands out as the first European economy to initiate a rate cut. This move could open the gate for potential rate adjustments by the ECB.

The Swiss National Bank surprised by slashing its interest rates to 1.5%, marking the first major central bank to do so in this economic cycle. The move reflects its confidence in the inflation trend, which currently stands at 1.2%, below the 2% target. Despite expectations for rate stability, the bank's president cited the effectiveness of inflation-fighting measures and the appreciation of the Swiss franc as rationale for the change. This decision led to a decline in the Swiss franc/dollar. Additional rate cuts are scheduled for year-end, factoring in concerns over Swiss economic growth and the strong France's impact on the manufacturing sector.

The next central bank likely to consider rate cuts could be the ECB. Despite inflation not reaching 2%, the economy remains fragile.
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