EU Economy: Weekly Commentary – 27 May, 2024
European Market Review
European bond yields rose, stock indices fell, EUR weakened, and Brent crude dropped.

European bond yields experienced an increase, while stock markets exhibited negative trends with most indices declining. The EUR weakened to 1.0869 against the USD. Brent crude oil prices dropped by over 2% amid a period of excess supply. Consequently, oil prices are expected to stay within the range of 80 to 85 in the short term due to a lack of new data.
Europe View Synopsis
Eurozone's recovery strengthens as PMI rises to 52.3; German deflation intensifies; UK services inflation spikes to 5.9%, delaying rate cut.

Eurozone's recovery strengthens as composite PMI rises to 52.3, driven by manufacturing output. Inflation softens, outlook positive. ECB eyes rate cut amid improving conditions. German deflation intensifies with a 3.3% producer price drop. Modest German economic rebound faces structural risks. UK services inflation rises to 5.9%, delaying rate cut to August/September.
Business activity
Eurozone's recovery gains momentum as composite PMI rises to 52.3, driven by manufacturing output. Despite inflation softening, the outlook is favourable. Strong Q1 continues into Q2, with a potential manufacturing turnaround. ECB eyes rate cut amid improving conditions, with manufacturing expected to expand by year-end.

The eurozone's economic recovery is gaining momentum, with the composite PMI rising from 51.7 to 52.3, driven by a notable increase in the manufacturing output. Despite some softening in inflation, the overall outlook for the region's economy appears increasingly favourable. Following a robust first quarter, the momentum continues into the second quarter as the May PMI exceeded expectations, particularly in manufacturing where output rose to 49.6, suggesting a potential turnaround from production declines. This shift marks a significant departure from the stagnation observed in 2023, propelled by improvements in domestic orders and favourable financial conditions alongside a promising global demand outlook, forecasting GDP growth of around 0.3-0.4% per quarter this year. While the European Central Bank may find relief in the May inflation softening, particularly in input and output prices, the upcoming rate decision remains crucial, with attention on service sector growth and wage trends, which could influence expectations of a rate cut despite the economic upswing.

Anticipating a shift, we foresee the manufacturing sector crossing into expansion territory, surpassing the threshold of 50 by year-end. Aligning with market sentiments, we anticipate a rate cut in June.
German PPI
Deflationary pressures intensified as producer prices dropped 3.3% YoY in April, driven by an 8.2% decline in energy prices and significant drops in intermediate goods. However, some sectors, like petroleum products and capital goods, saw price hikes. Despite this, the German economy shows promising signs of recovery, offering hope for sustained growth in 2025.

Deflationary forces are intensifying as producer prices fell 3.3% YoY in April, following a 2.9% drop in March. Energy prices, especially natural gas, and electricity, drove the decline with an 8.2% fall, while intermediate goods like paper, basic chemicals, and metals also saw significant price drops. However, some areas, such as petroleum products, capital goods, and consumer durables, experienced price increases. Notably, overall food prices fell slightly despite substantial rises in confectionery and butter prices. Compared to March, producer prices rose 0.2%, with capital goods and consumer non-durables contributing to the rebound.

The German economy appears to be consistently displaying positive indicators, signalling a broader recovery of economic strength on the horizon. We expect further progress throughout the remainder of this year and into 2025, fostering hopes for a sustained economic revival.
German economic growth
Germany's economy has modestly rebounded, driven by construction and exports, but faces structural weaknesses and cyclical risks, delaying strong recovery.

The German economy has emerged from stagnation in the first quarter, with GDP growth of 0.2% QoQ, rebounding from a revised -0.5% in the previous quarter. This modest growth was driven by increased construction activity, benefiting from mild winter weather, and improved net exports, despite declines in private and public consumption. While this marks a positive shift, structural weaknesses and potential cyclical headwinds, such as higher oil prices and rising insolvencies, pose risks to sustained recovery. Optimism has returned somewhat, buoyed by stronger sentiment indicators and expectations of stronger wage growth supporting private consumption. However, the economy still faces significant challenges and is not yet back to its early 2022 levels. The German economy is forecast to grow by approximately 0.3% this year.

We do not anticipate a strong recovery until 2025; this year, we expect only modest growth, with the German economy likely to lag behind the overall EU economy.
UK Inflation
April UK services inflation rose to 5.9%, higher than expected, reducing the likelihood of a June rate cut. Headline CPI fell to 2.3%. A rate cut is anticipated in August or September as the BoE awaits more data.

The latest UK inflation figures for April reveal a significant rise in services inflation, coming in at 5.9%, higher than the consensus forecast of 5.4% and the Bank of England’s 5.5% estimate. This unexpected increase, driven by annual price hikes and a notable spike in rents, reduces the likelihood of the BoE cutting rates at its June meeting, though a rate cut remains possible. The data suggests more noise than signal regarding the broader inflation trend. While headline CPI is expected to dip below target with May’s data and stabilize around 2% for the rest of the year, the stubborn April services inflation supports our base case for the first rate cut to occur in August or September, allowing the BoE additional time to assess inflation trends. Notably, headline CPI dropped to 2.3% in April from 3.2% in March.

The housing market continues to put pressure on inflation. We do not expect a rate cut until August or September, as the BoE will wait for more data before making a decision.
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