EU Economy: Weekly Commentary – 26 February, 2024
Europe View Synopsis
Inflation is on track with business activity improving overall. German manufacturing sector continues to suffer.

Eurozone inflation dipped, services remain putting pressure on it, and core inflation reached its lowest since March 2022. Despite economic challenges, optimism exists, with decreasing wages as a buffer for inflation. Business activity is easing, notably in the rise of the composite PMI. Concerns, particularly in Germany (manufacturing sect. remains struggling), impact discussions on a potential ECB rate cut in June. Consumer confidence improved slightly but remains below the long-term average in both the EU and the euro area. We do not expect cuts, at least up to June.
Eurozone inflation edged lower last month. Inflation to services, which rose by 1.73% YoY, remains putting pressure on overall inflation.

The eurozone inflation rate for January 2024 has been at 2.8% (vs 2.9% Dec). Core inflation continues its descent, dropping to 3.3% (vs 3.4% Dec), marking the lowest level since March 2022. In the same period, the YoY decline in energy prices moderated to 6.1%, showing improvement from the 6.7% decrease observed in December, while food prices saw a rise of 6.9%.

Looking ahead at inflation in the eurozone, there is optimism for improvement. The positive aspect of decreasing wages is noted, as it could act as a preventive measure against a potential second wave of inflation. Notably, the economic situation in the European Union is different from that of the United States, characterised by a weak economy and declining wages. ECB could cut rates earlier than the Fed.

These developments present a favourable outlook for the ECB. The downward trajectory in inflation, coupled with economic challenges, suggests a consideration for rate reduction. However, caution is urged, taking into account the rebound in inflation in the US. Our perspective aligns with the possibility of a rate cut in June.
Business Activity
The composite PMI rose in February, indicating that the eurozone economic situation is improving. The Eurozone manufacturing sector continues to be dragged down by Germany. Germany is currently acting as a brake on the Eurozone economy. Services inflation remains a headwind for upcoming ECB rate cuts.

The eurozone confronts economic challenges, with the service sector displaying signs of improvement while manufacturing grapples with a decline in new orders, causing the output index to fall from 46.6 to 46.2. Notably, France resiliently achieved its best PMI in 9 months at 47.7, while Germany experienced a setback with its composite PMI dropping to 46.1, underscoring the widening economic gap within the eurozone. Despite a reduction in production disruptions reflected in a drop in supply delivery times, and falling prices for goods, concerns persist for the European Central Bank, particularly as services businesses indicate a faster rise in prices, pointing to heightened input costs.

February sees a positive trend with supply delivery times decreasing, suggesting potential relief from disruptions to eurozone production. This positive development is mirrored in falling prices for goods. However, the inflationary outlook remains concerning for the European Central Bank, as services businesses indicate faster-rising prices joined to increased input costs. Despite recent moderate inflation, these indicators provide arguments for those advocating caution against premature rate hikes.

Norman Liebke, Economist at Hamburg Commercial Bank, said: “Our forecast remains that the ECB will cut interest rates for the first time in June”

We think that Germany will be the drag on economic growth in the EU in the H2. It suffering more than expected and we don’t see signals of recovery in the short term. The scenario is pushing the ECB to cut rates.
Consumer and business sentiment
Consumer confidence improved around the EU. The companies in Germany remain pessimistic about the future. Still far from a recovery.

In February 2024, there was a modest increase in the consumer confidence indicator, climbing by 0.4 percentage points in the EU and 0.6 points in the euro area. However, despite this improvement, consumer confidence remains notably below the long-term average at -15.8 (EU) and -15.5 (euro area) points.

January witnessed a decline in sentiment among German companies, with the IFO Business Climate Index dropping from 86.3 points in December to 85.2 points. This decline signifies a persistent recession in the German economy. While the manufacturing sector showed a slight improvement in the Business Climate Index, service providers faced a significant decline due to deteriorating current situation assessments. In trade, the index hit its lowest point since October 2022, reflecting dissatisfaction among both wholesalers and retailers. The construction sector also experienced a downturn, with companies reporting worsened current business situations and gloomier future expectations. Overall, the economic landscape in Germany presents challenges, characterized by declining confidence and widespread pessimism across various sectors.

Our view is that German sentiment will not improve at least until the ECB cuts rates in the second half of the year. Germany could be the drag of Eurozone growth in this first half of the year.
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