A Cautious Recovery Amidst Global Uncertainty
Euro Area recovery faces inflation, geopolitical risks. ECB easing possible, but fiscal prudence crucial for debt, market confidence.
Monday, August 12, Week 33
Euro Area Macroeconomic Overview: A Balancing Act
This report provides a comprehensive analysis of the Euro Area's macroeconomic landscape over the past five months and offers insights into potential developments over the next five weeks. The Euro Area economy is projected to pick up speed in 2025, driven by falling inflation, a tight labour market, and sustained real wage growth. However, concerns remain about the impact of the war in Ukraine, escalating trade tensions, and the potential for a structural upward trend in public spending.
Fiscal Prudence Amidst Uncertainty
The Euro Area's fiscal outlook is characterised by a balancing act between supporting economic growth and ensuring debt sustainability. While GDP growth is picking up, public finances are projected to remain largely unchanged in 2025, with the budget deficit expected to remain at 2.8% of GDP. The European Fiscal Board (EFB) advocates for a sizable restrictive fiscal impulse in 2025 to address the underlying expenditure drift and preserve the relatively benign assessment of sovereign risks by financial markets.
In Review
The first half of 2024 saw the Euro Area navigate a complex fiscal landscape. The severe economic downturn clause, activated in 2020, was deactivated at the end of 2023, but the implementation of EU fiscal surveillance in 2024 remains uncertain. The Commission's proposal to delay the adoption of excessive deficit recommendations for 2024 sets a precedent, creating uncertainty around the fiscal stance in 2025. Several large Euro Area countries are projected to have worse fiscal positions in 2024 than previously expected and recommended, potentially leading to a higher level of fiscal support than anticipated in 2025.
Charting a Sustainable Course
The coming five weeks will be crucial for shaping the Euro Area's fiscal trajectory. The Commission is expected to release reference trajectories for Member States later this year, providing clearer guidance on fiscal policy for 2025. The draft budgetary plans for 2025, to be released by national governments, will reveal whether they intend to implement the necessary discretionary measures to secure a meaningful improvement in the underlying fiscal position. The market will closely monitor these developments for signs of commitment to fiscal prudence.
Economic Situation
The Euro Area's economic situation is characterised by a mix of positive and negative developments. While private consumption is expected to drive economic growth in 2025, fueled by falling inflation and a tight labour market, concerns remain about the impact of the war in Ukraine, escalating trade tensions, and the potential for a structural upward trend in public spending.
A Gradual Recovery
The Euro Area economy has shown signs of gradual recovery over the past five months. GDP growth in the second quarter of 2024 was 0.3%, in line with the first quarter. Inflation has continued to decline, reaching 2.5% in June, but remains above the ECB's target. The labour market remains resilient, with unemployment falling to 6.4% in May. However, industrial production has been weak, contracting by 0.6% in June 2024.
Navigating Uncertainty
The economic outlook for the next five weeks is clouded by uncertainty. Key data releases, including the July inflation report (August 20th) and the August PMI surveys (August 22nd), will provide further insights into the strength of the recovery. The ECB's August meeting (August 18th) will be closely watched for any signals on the future path of monetary policy. Global economic trends, particularly the slowdown in China and the ongoing war in Ukraine, will continue to influence the Euro Area's economic outlook.
Monetary Policy: A Cautious Pivot
The European Central Bank (ECB) has begun a cautious pivot towards monetary easing, but remains committed to bringing inflation back to its 2% target. The ECB's first interest rate cut on June 6th, 2024, signalled a shift in policy stance, but the central bank has emphasised that it will maintain restrictive policy rates as needed.
From Tightening to Easing
The ECB's monetary policy stance has shifted from tightening to easing over the past five months. After raising interest rates aggressively in 2023, the ECB paused rate hikes in early 2024 and then cut rates in June. This shift was driven by concerns about slowing economic growth and the impact of the war in Ukraine on energy prices. The ECB's decision-making process has been influenced by both internal factors, such as the evolving inflation outlook, and external pressures, such as the actions of other major central banks.
Gauging the Pace of Easing
Market expectations are for the ECB to continue easing monetary policy in the coming five weeks. The ECB's August meeting will be crucial for gauging the pace of easing. The market will closely monitor the ECB's communication for any signals on the timing and magnitude of future rate cuts. External factors, such as the Federal Reserve's policy decisions and developments in the war in Ukraine, could also influence the ECB's decision-making process.
Macroeconomic Outlook: A Path to Recovery?
The Euro Area's macroeconomic outlook is characterised by uncertainty, but there are signs that the economy is on a path to recovery. The key question is whether the ECB can successfully navigate the challenges of high inflation, slowing growth, and geopolitical risks.
Navigating the Risks
The Euro Area's macroeconomic outlook for the next five weeks is cautiously optimistic, but several risks could derail the recovery.
1. Inflationary Pressures: Despite recent declines, inflation remains above the ECB's target, and there are risks that it could prove more persistent than expected. Key events to watch include the release of the July inflation report (August 20th) and the August PMI surveys (August 22nd).
2. Geopolitical Uncertainty: The war in Ukraine continues to pose a significant risk to the Euro Area economy, both through its direct impact on energy prices and trade and through its broader impact on global sentiment. Key events to watch include any escalation in the conflict and the impact of sanctions on Russia.
3. Fiscal Slippages: The potential for fiscal slippages in some Euro Area countries could undermine market confidence and lead to higher borrowing costs. Key events to watch include the release of the draft budgetary plans for 2025 and the Commission's assessment of these plans.
Action Points for Forex Traders:
Monitor the ECB's communication: The ECB's August meeting (August 18th) will be crucial for gauging the pace of monetary easing. Pay close attention to the ECB's communication for any signals on the timing and magnitude of future rate cuts.
Watch for signs of inflation: The release of the July inflation report (August 20th) and the August PMI surveys (August 22nd) will provide further insights into the trajectory of inflation.
Assess geopolitical risks: The war in Ukraine continues to pose a significant risk to the Euro Area economy. Monitor developments in the conflict and the impact of sanctions on Russia.
Economic Indicators: A Closer Look
Economic Growth:
GDP Growth Rate: The Euro Area GDP expanded 0.3% in the second quarter of 2024.
Industrial Production MoM: Industrial production in the Euro Area decreased by 0.6% in June 2024. The forecast for July is -1.3%.
Price Changes (Inflation):
Inflation Rate YoY: Annual inflation rate in the Euro Area edged up to 2.6% in July 2024 from 2.5% in June. The forecast for August is 2.2%.
Core Inflation Rate YoY: The annual core inflation rate in the Euro Area remained steady at 2.9% in July 2024. The forecast for August is 2.4%.
Labour:
Unemployment Rate: Unemployment Rate In the Euro Area increased to 6.50 percent in June from 6.40 percent in May of 2024. The forecast for July is 6.9%.
Business Confidence:
ZEW Economic Sentiment Index: The ZEW Indicator of Economic Sentiment for the Euro Area sank by 7.6 points to 43.7 in July of 2024.
Ifo Business Climate Index: Data not available.
Composite PMI: The final HCOB Eurozone Composite PMI for July 2024 was slightly revised higher to 50.2 from the preliminary 50.1. The forecast for August is 50.7.
Consumer Sentiment:
Consumer Confidence: The consumer confidence indicator in the Euro Area rose by 1 percentage point from the previous month to -13 in July 2024. The forecast for August is -13.5.
Retail Sales MoM: Retail sales in the Euro Area fell 0.3% month-over-month in June 2024. The forecast for July is 0.00%.
GfK Consumer Climate: The GfK Consumer Climate Indicator for Germany climbed to -18.4 heading into August 2024. The forecast for September is -22.00.
Trade:
Balance of Trade: The Euro Area posted a trade surplus of EUR 13.9 billion in May 2024. The forecast for June is EUR 23.4 billion.
These indicators suggest that the Euro Area economy is in a state of flux, with both positive and negative trends at play. The coming month will be crucial for determining whether the recovery can gain momentum or whether the risks to the outlook will materialise.
Conclusion: A Delicate Recovery
The Euro Area economy is facing a delicate recovery, with a mix of supporting and challenging factors. While private consumption is expected to drive growth, inflation remains a concern, and geopolitical risks continue to cloud the outlook. The ECB's cautious pivot towards monetary easing could provide support, but fiscal prudence will be essential for ensuring debt sustainability and maintaining market confidence.
Sources:
European Central Bank
EUROSTAT
Trading Economics
Federal Statistical Office
INSEE, France
S&P Global
Centre for European Economic Research (ZEW)
GfK Group
Ifo Institute
Ministère de l'Économie et des Finances
Bundesagentur für Arbeit
European Fiscal Board