European bond yields fell on rate cut expectations, stock markets dropped, and Brent crude oil declined on weak economic data.

European bond yields declined over the week as ongoing economic data intensified expectations of an ECB rate cut before September. The market now estimates over a 90% chance of a rate cut in September. The yield spread between benchmark French and German bonds tightened by 78.2 basis points. Meanwhile, the stock market experienced a downturn, influenced by the decline in the US market. The euro remained relatively stable against the dollar, trading at 1.0835, while Brent crude oil prices dropped nearly 3% due to concerns over weakening demand amid soft global economic data.

Eurozone Q2 2024 GDP growth was robust, but signs of a slowdown and rising inflation complicate ECB rate cut decisions. Spain grew, Germany contracted, and unemployment rose. The UK cut rates to 5%, with cautious future reductions.

The Eurozone saw progress in Q2 2024 with GDP growth exceeding expectations, but emerging signs of a slowdown suggest the ECB might need further rate cuts. Spain led with a 0.8% quarterly growth, contrasting with Germany's 0.1% contraction. Despite a stable 0.3% QoQ GDP increase, uncertainties persist, particularly with Germany's economy shrinking due to weak investment and industrial activity. Inflation rates in the Eurozone rose slightly above forecasts, complicating the ECB's decision on potential rate cuts. Manufacturing PMI fell sharply, signalling a tough period ahead, while unemployment in the Eurozone increased to 6.5%, exacerbated by weak consumption and labour market pressures. In the UK, the Bank of England cut rates to 5% but remains cautious about future reductions, with further cuts possible depending on inflation and wage growth trends.

The Eurozone's recovery showed progress in Q2, but emerging slowdown signs suggest the ECB should consider further rate cuts. Spain's growth contrasts Germany's contraction, and uncertainties cloud the region's future economic outlook.

The Eurozone demonstrated signs of recovery from extended stagnation in the second quarter, with GDP growth exceeding expectations. However, emerging signs of a slowdown suggest that this recent growth acceleration, compared to 2023, should not dissuade the ECB from considering additional interest rate cuts. Although the 0.3% QoQ GDP increase matches the first quarter's performance and reflects some recovery driven by low unemployment and stable inflation, the overall growth outlook remains cautious due to uncertainties impacting the region’s future economic trajectory.

Disparities within the Eurozone are notable, with Spain emerging as the strongest performer, reporting a 0.8% quarterly growth, while Germany, the largest economy, experienced a 0.1% contraction, highlighting its struggle as a weak link in the recovery. Despite some positive data, weakening sentiment indicators, such as declining PMI and reduced services sentiment, point to a challenging third quarter. Business confidence is diminishing, and persistent weaknesses in manufacturing further dampen the outlook, reinforcing the ECB’s argument for potential rate cuts to stimulate domestic demand and address insufficient inflationary pressure.

Focusing on the German economy, fell back into contraction in the Q2, with GDP declining by 0.1% QoQ, following a modest 0.2% growth in the first quarter. Year-on-year, GDP also decreased by 0.1%. Estimates suggest weak investment, manufacturing and construction sectors as key contributors to this downturn. The earlier optimism of a recovery, driven by mild winter weather and a revised fourth-quarter GDP, has not yet translated into sustained economic health, leaving the German economy smaller than it was two years ago.

Falling sentiment indicators and weak industrial orders in Germany, combined with global economic slowdowns and trade tensions, dampen prospects for a strong export-driven recovery. High inventory levels, weak industrial activity, and rising insolvencies further strain the economy. Nonetheless, potential improvements in industrial production and consumer spending, supported by increased real wages, could provide some positive developments. Despite persistent stagnation and the likelihood of continued slow growth, a modest rebound in the latter half of the year remains a possibility.

We anticipate a modest acceleration in Eurozone growth in the latter half of the year, supported by potential rate cuts in September and high wages. In Germany, despite ongoing constraints from the manufacturing sector, we foresee a gradual recovery toward year-end.

Eurozone inflation figures are higher than expected, complicating a potential September rate cut by the ECB. With persistent inflationary pressures and economic divergence among member states, better data for August and September will be crucial for any decision.

Preliminary data for July indicates that both headline and core inflation rates were slightly higher than expected. The YoY CPI rose to 2.6% from 2.5% in June, exceeding the forecast of 2.5%. Core inflation remained steady at 2.9%, above predictions, while energy inflation increased to 1.3%. Although inflation for non-energy industrial goods stayed low at 0.8% and unprocessed food inflation fell to 1.0%, the ECB's primary concern is services inflation, which decreased only marginally to 4.0% from 4.1% in June.

Looking ahead, the ECB's forecasts from June projected headline inflation of 2.3% for Q3 and 2.5% for Q4, with core inflation expected to be 2.7% in Q3 and 2.6% in Q4.

In Germany, July inflation data shows that headline inflation has risen to 2.3% YoY from 2.2% in June, exceeding the ECB's 2% target. The broader European measure also increased, reaching 2.6% from 2.5% the previous month. Persistent inflationary pressures are attributed to lingering base effects and prior government interventions. Services inflation remains around 4% YoY despite a slight drop in hotel and restaurant prices, while costs in the leisure and clothing sectors have increased. Monthly fluctuations reflect modest price reductions in clothing and hospitality, likely due to summer sales and post-Euro 2024 adjustments. Inflation is projected to remain within the 2% to 3% range, influenced by diminishing energy base effects and rising wages, with significant wage growth reductions appearing unlikely in the latter half of the year.

Given the current data, a rate cut in September appears less likely, and better inflation figures for August and September will be crucial. The economic divergence, with Germany lagging while countries like France and Spain show robust recoveries, adds to the uncertainty. Although the probability of a rate cut has decreased slightly, there is still time for new data to influence the decision. Currently, interest rates remain restrictive, and while the inflation trend is expected to continue downward, the ECB will need more favourable data before making a definitive decision. Persistent inflationary pressure will likely continue to challenge the ECB in deciding whether to cut rates to support the weakening recovery or maintain rates to combat inflation.

The final stage of reducing inflation is often the toughest; nevertheless, we remain confident in the ongoing positive trend. Monthly, inflation has remained unchanged, while the core rate has declined by 0.2%, indicating deflationary trends. Given the current macroeconomic environment, we expect the ECB to implement a further rate cut in September.

Eurozone manufacturing saw a sharp decline in June, with PMI dropping to 45.8. Output fell at the fastest rate in 2024, though business confidence remains high despite weak new orders.

The latest Eurozone Manufacturing PMI data reveals a significant downturn in the Eurozone’s manufacturing sector as of June 2024. The Eurozone Manufacturing PMI fell to 45.8, a 2-month low and a marked decline from May’s 47.3. The PMI Output Index also dropped to 46.1, its lowest point in six months. This decline in manufacturing activity is driven by a faster-than-expected fall in production, new orders, and employment levels, with input costs rising for the first time since February 2023. Despite these challenges, the 12-month outlook for output remains optimistic. The survey highlights a reduction in output charges and a continued decrease in new export orders, reflecting ongoing pressure on the sector.

In June, the majority of national manufacturing sectors experienced weaker performance, with Greece leading despite its own 6-month low PMI. Spain and the Netherlands also reported slower growth, while Germany remained the weakest performer. The Eurozone manufacturing sector saw the steepest output contraction of 2024, accompanied by a significant decline in new orders and purchasing activity. Despite these setbacks, business confidence held steady at a 27-month high, supported by global manufacturing growth and a resilient outlook for the coming year. However, the persistent drop in forward-looking new orders suggests any substantial recovery may be delayed until late summer or early fall.

We expect that the manufacturing sector will hinder the European economy in 2024, with no significant improvements expected until late in the year, followed by a stronger recovery in 2025.

Eurozone unemployment rose to 6.5% in May, with labour market softening expected. Germany's jobless rate increased. Demographic shifts and economic pressures may lead to further labour shortages, weaker consumption, and a fragile economic recovery in the Eurozone.

The Eurozone's unemployment rate increased slightly to 6.5% in May, with 41,000 more people out of work. Despite demographic challenges tightening the labour market, cyclical unemployment fluctuations are expected to persist. Recent data suggests the jobless rate could rise further, as employment expectations in manufacturing and services weakened in July. The PMI survey also pointed to stagnant business activity, ending six months of job creation and complicating employment prospects for new labour market entrants.

In Germany, unemployment rose by 82,100 in July, bringing the total to 2.809 million, with the seasonally adjusted rate steady at 6%. This increase marks the second-worst July report since 2004. Despite record employment levels, with over 46 million people working, private consumption has declined in 2023 and remains weak in early 2024, suggesting job growth has been concentrated in part-time and low-wage positions. The labour market faces further pressure from rising insolvencies, waning recruitment, and demographic changes, which may worsen labour shortages but drive wage growth. The gradual cooling of the labour market could contribute to subdued private consumption despite robust wage increases.

The ECB has relied on household consumption for economic recovery, driven by higher real disposable income. However, if labour market confidence erodes, households may opt to save rather than spend, dampening consumption. The European Commission’s consumer survey indicates rising unemployment concerns since April, highlighting the fragility of the Eurozone’s economic recovery despite a historically low unemployment rate.

We anticipate a slight rise in unemployment in the second half of the year, which could dampen economic growth as consumers reduce spending and prioritize saving.

The BoE cut rates to 5% but remains cautious about future cuts. Improvements in inflation and wage growth may lead to further reductions later this year.

The Bank of England has recently reduced interest rates for the first time in this cycle, lowering them by 0.25pp to 5%. Despite this move, the Bank has been notably reserved about suggesting further rate cuts shortly. The official statement did not refer to additional cuts, emphasizing the need for rates to remain restrictive for a "sufficiently long" period. The decision to cut rates was closely contested, with five committee members voting for the reduction while four members preferred to maintain the current rate. The minutes of the meeting indicate that the decision was “finely balanced,” reflecting the committee’s cautious approach.

Looking ahead, there are indications that the Bank of England may cut rates further by year-end, contingent on improvements in services inflation and wage growth. Although the Bank has not historically committed to future policy changes in advance, the ongoing high levels of services inflation—currently at 5.7%—and the potential for future overshoots could prompt additional rate cuts. The Bank’s current inflation forecasts align with market expectations of further rate reductions, with a projected mean inflation rate of 2% in two years.

We expect that the Bank may implement one or two more rate cuts this year, in September and December if inflation data trends favourably.