EU Economy: Weekly Commentary – 29 July, 2024
European Market Review
European bond yields fell amid political uncertainty and rate cut speculations, narrowing French-German spreads. Mixed stock performance, stable euro, and a 3% drop in Brent crude prices.

European bond yields declined throughout the week due to political uncertainty, the weak economy, and Guindos' remarks about potential rate cuts in September. This environment has heightened the likelihood of another interest rate reduction by the European Central Bank (ECB) in September, with the market pricing in an 80% chance of this outcome. The yield spread between French and German benchmark bonds narrowed by 4.3 basis points. Meanwhile, stock market performance was mixed, but sentiment remains positive in anticipation of rate cuts. The euro remained relatively stable against the dollar at 1.0856, and Brent crude oil prices dropped by nearly 3% due to concerns over weaker-than-expected demand.
Europe View Synopsis
Luis de Guindos foresees a possible September rate cut, with inflation moderating next year, but consecutive cuts are uncertain due to mixed data.

Luis de Guindos, Vice President of the ECB, signalled a potential rate cut in September, contingent on comprehensive inflation and wage data and new macroeconomic projections. He expects inflation to moderate next year if wage increases normalize, aiming for a 2% inflation target by the end of 2025. Market indicators suggest an 80% probability of a September rate cut, though consecutive cuts are uncertain due to mixed economic data. Eurozone PMIs reveal a sluggish recovery, with weakening manufacturing and services sectors, particularly in Germany and France, suggesting potential downward revisions to ECB growth forecasts. Consumer confidence is improving, approaching the EU’s long-term average, but the Employment Outlook Indicator has declined. In Germany, the ifo Business Climate Index dropped, reflecting deteriorating sentiment across all sectors, signalling a challenging economic outlook with significant hurdles anticipated for 2024 and potential improvements expected in 2025.
ECB’s Luis de Guindos Speech
Luis de Guindos expects a September rate cut, with inflation moderating next year, but consecutive cuts are uncertain.

Luis de Guindos, Vice President of the ECB, highlighted September as a crucial month for making a rate cut decision. By then, comprehensive inflation and wage data, along with new macroeconomic projections, will be available, enabling a more informed reassessment of monetary policy. Guindos also noted that inflation is expected to remain at current levels until next year when wage dynamics are anticipated to help bring it down. "If wage increases normalize, services inflation, which is highly sensitive to wage trends, will moderate, allowing us to achieve the 2% inflation target by the end of next year," he explained.

Market indicators currently suggest an approximately 80% probability of a rate cut in September, a likelihood that has remained consistent over the past few weeks.

In alignment with Guindos' statements, we expect the first rate cut in September. However, given the mixed nature of the inflation and economic data, this may not signal the beginning of a series of consecutive cuts. As a result, the short end of the yield curve may encounter resistance to significant declines.
Business Activity
The July PMIs reveal a sluggish eurozone recovery, with weakening manufacturing and services sectors. The economic outlook for major economies like France and Germany worsens, raising concerns for the ECB, which may need to revise its growth forecasts downward.

The July PMIs paint a grim picture of the eurozone's economic recovery, signalling further momentum loss in both the manufacturing and services sectors. This downturn is worrisome for the ECB, as today's figures offer no grounds for optimism in the ongoing battle against inflation. Despite a hopeful start to the year with improved business sentiment and unexpected GDP growth in the first quarter, recent developments have been a stark reminder of the challenges ahead. The PMI composite index fell to 50.1 in July from 50.8 in June, hovering perilously close to the contraction threshold. The manufacturing PMI dropped to 45.6, highlighting the sector's persistent weakness, while services also saw a decline to 51.9. Though selling price expectations softened, rising input costs indicate that inflation concerns remain pressing.

The economic outlook for the eurozone's major economies underscores these challenges. While France saw a slight improvement in its PMI, it remained below 50, reflecting deteriorating manufacturing sentiment despite a boost in services likely linked to the upcoming Olympic Games in Paris. Conversely, Germany experienced a sharp decline in its PMI composite, falling well below 50 as both manufacturing and services sentiment worsened. This disappointing growth trajectory casts doubt on the ECB's forecasts, which had already been adjusted to reflect downside risks. The first quarter's unexpected growth, driven by net exports and construction, now seems like a brief respite, with Q2 data suggesting a significant slowdown. The ECB's revised projections for economic recovery appear increasingly premature, and further cut rates may be necessary come September.

We anticipate that the manufacturing sector will be the drag in the European economy throughout 2024. Significant improvements in the sector are unlikely until there are further cuts in interest rates.
Consumer Confidence
Consumer confidence improves, nearing EU's long-term average, while ESI remains stable and EEI declines for the third consecutive month.

Consumer confidence is showing signs of improvement, although it remains in negative territory, gradually approaching the EU's long-term average. The latest data indicates a rise in consumer confidence by 0.7 percentage points (pp) in the EU and by 1.0 pp in the euro area, reaching -12.2 points and -13.0 points respectively, closer to their long-term averages. The Economic Sentiment Indicator (ESI) remained largely stable with a slight decrease of 0.2 points, at 96.4 for the EU and 95.9 for the euro area. Conversely, the Employment Outlook Indicator (EEI) declined for the third consecutive month, with the EU nearing its long-term average at 100.4 and the euro area falling to 99.7. Despite the ESI's stability, remaining around 4 points below its long-term average, the EEI's gradual decline has narrowed the gap between these two indicators.

We anticipate an improvement in consumer sentiment as we approach September, coinciding with the expected rate cuts by the ECB.
German Sentiment
The ifo Business Climate Index in Germany dropped to 87.0 points in July, indicating worsening business sentiment across all sectors, including manufacturing, services, trade, and construction, reflecting growing dissatisfaction and increased scepticism about the economic outlook.

Sentiment among companies in Germany has markedly declined, as evidenced by the ifo Business Climate Index dropping to 87.0 points in July from 88.6 in June. This reflects growing dissatisfaction with the current business situation and increased scepticism about the coming months, indicating that the German economy remains in crisis. The manufacturing sector saw a significant drop, with poorer assessments of the current situation, decreased expectations, and reduced order backlogs, while capacity utilization fell to 77.5%. The service sector's index, after rising recently, fell again due to more pessimistic expectations and slightly less positive views of the current situation, now 6 percentage points below the long-term average. In the trade sector, the business climate declined as retailers expressed less satisfaction and heightened doubts about the future, and the construction sector also experienced a decline with poorer assessments and ongoing significant pessimism. This ifo index plunge follows a similar drop in the Composite PMI, where the current conditions index fell by 1.2 points and the expectations index unexpectedly fell by 1.9 points, with conditions deteriorating across manufacturing, services, construction, and retail sectors.

We anticipate that Germany will face significant challenges in its recovery, expecting a stagnant year in 2024. However, we project that 2025 will mark the beginning of improvements in Europe's leading economy.
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