Euro-Area Growth Stalls Amid Weakening Manufacturing and Persistent Inflation
Euro-Area economy struggles with manufacturing, inflation, and geopolitical factors. Monitor Q2 GDP, July inflation, ECB meeting, energy, geopolitics, and fiscal policy.
Saturday, 20 July, Week 29
Euro-Area Fiscal Policy: Walking a Tightrope Between Support and Sustainability
Fiscal policy in the Euro-Area has been navigating a challenging landscape over the past five months. The bloc has been gradually withdrawing COVID-19 support measures, leading to a significant reduction in headline deficits. However, the withdrawal has been partially offset by the introduction of new measures to mitigate the impact of the energy crisis triggered by the war in Ukraine and to support refugees fleeing the conflict. This has resulted in a mixed picture for fiscal policy, with headline numbers suggesting a move towards consolidation, while underlying expenditure trends point to a continued expansionary stance, particularly in high-debt countries. The European Commission's 2023 spring forecast estimated that the headline deficit for the euro area shrank by close to 1.5% of GDP in 2022, translating into a reduction in the structural primary balance from 2.8% of GDP in 2021 to 2.0% of GDP in 2022. This improvement was largely driven by the phasing out of COVID-19 support measures, which had a deficit-reducing impact of 2.5 percentage points of GDP. However, new energy support measures, amounting to 1.2% of GDP, and support for Ukrainian refugees, estimated at 0.1% of GDP, partially offset the consolidation effort.
Looking ahead, the next five weeks will likely see limited new fiscal policy initiatives as governments enter the summer recess. The focus will shift to the implementation of existing measures, including the disbursement of funds under the Recovery and Resilience Facility. The impact of fiscal policy on the macroeconomic situation will depend on the effectiveness of these measures in stimulating growth and on the evolution of inflation. The Commission's analysis suggests that the fiscal stance will remain broadly neutral in 2023, with a structural primary balance of -1.9% of GDP. However, the outlook is subject to significant uncertainty, particularly regarding the future path of energy prices and the potential for further fiscal measures to be introduced in response to the ongoing war in Ukraine. For forex traders, understanding the fiscal policy outlook is crucial for assessing the long-term health of the Euro-Area economy and the potential impact on the euro. A more restrictive fiscal policy could help to contain inflationary pressures and support the euro, but it could also dampen economic growth. Conversely, a more expansionary fiscal policy could boost growth but also fuel inflation and weigh on the euro.
Euro-Area Economy: Losing Momentum Amid Multiple Headwinds
The Euro-Area economy has been losing momentum in recent months, facing a confluence of headwinds, including weakening manufacturing activity, persistent inflation, and heightened geopolitical uncertainty. While the services sector has continued to expand, albeit at a slower pace, manufacturing activity has contracted for 17 consecutive months, according to the HCOB Manufacturing PMI. The labour market has remained resilient, with the unemployment rate at a record low of 6.4% in May 2024, but wage growth has been insufficient to offset the impact of high inflation on real incomes. The ECB's June 2024 macroeconomic projections forecast economic growth to pick up to 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026. However, the outlook is subject to significant downside risks, including a weaker global economy, an escalation of geopolitical tensions and a stronger than expected impact of monetary policy tightening.
Over the next five weeks, economic data releases will be closely watched for signs of whether the recovery is gaining traction or losing momentum. Key indicators to monitor include:
Economic Growth:
Euro Area GDP Growth Rate QoQ Flash Q2 (Tuesday, 30 July, Week 31): The flash estimate for Q2 GDP growth is expected to show a slowdown from the 0.3% recorded in Q1. The final estimate for Q1 GDP growth, released on 7 June, confirmed a 0.3% expansion, driven by net trade. However, household consumption and government spending slowed, while fixed investments continued to decline. The June 2024 Eurosystem staff macroeconomic projections suggest that "The euro area economy recovered at the start of 2024 by more than expected in the March 2024 ECB staff projections, with a boost from net trade and rising household spending. Incoming information suggests continued growth in the short run, at a higher pace than previously foreseen."
Germany Ifo Business Climate Index (July) (Thursday, 25 July, Week 30): The Ifo index is a key gauge of business confidence in Germany, the Euro-Area's largest economy. The index unexpectedly declined to 88.6 in June 2024 from 89.3 in May, below forecasts of 89.7. The readings showed sentiment has deteriorated at companies and the German economy is having difficulty overcoming stagnation. A further decline in the index would point to a weakening economic outlook.
Inflation:
Euro Area Inflation Rate YoY Flash JUL (Wednesday, 31 July, Week 31): The flash estimate for July inflation is expected to show a slight uptick from the 2.5% recorded in June. Annual inflation rate in the Euro Area was confirmed at 2.5% in June 2024, lower than 2.6% in May and 5.5% a year earlier. Prices eased for energy (0.2% vs 0.3%) and food, alcohol and tobacco (2.4% vs 2.6%). On the other hand, inflation was steady for services (4.1%) and non-energy industrial goods (0.7%).
Germany Inflation Rate (July) (Wednesday, 17 July, Week 29): German inflation data is often seen as a bellwether for the Euro-Area as a whole. Annual inflation rate in Germany fell to 2.2% in June 2024, down from 2.4% in the previous month, consistent with preliminary estimates. Prices slowed for goods (0.8% vs 1% in May), while energy costs dropped at a faster pace (-2.1% vs -1.1%), counterbalancing a quicker increase in food prices (1.1% vs 0.6%). A further increase in German inflation would add to concerns about inflationary pressures in the bloc.
Labour Market:
Euro Area Unemployment Rate (June) (Monday, 15 July, Week 29): The unemployment rate is expected to remain at its record low of 6.4%. However, any increase in the rate would be a sign of weakness in the labour market. The unemployment rate in the Euro Area stood at an all-time low of 6.4% in May 2024, unchanged from April and matching market forecasts. Still, the number of unemployed individuals rose by 38 thousand from the prior month to 11.078 million.
Germany Unemployment Rate (June) (Sunday, 7 July, Week 27): Germany's seasonally adjusted jobless rate rose to 6% in June 2024, the highest since May 2021 and above market forecasts of 5.9%. The number of unemployed individuals increased by 19 thousand to 2.781 million in June, marking a 18th consecutive period of rising unemployment, and higher than forecasts of 15 thousand, indicative of the weak economic development in Germany.
Business Confidence:
Germany ZEW Economic Sentiment Index (July) (Tuesday, 16 July, Week 29): The ZEW index is a forward-looking indicator of economic sentiment. The ZEW Indicator of Economic Sentiment for Germany declined to 41.8 in July 2024, the first fall in a year and the lowest level in four months, compared to 47.5 in June and forecasts of 42.5. The economic outlook is worsening, amid falling exports, political uncertainty in France and the lack of clarity regarding future monetary policy by the ECB. A further decline in the index would point to a worsening economic outlook.
Germany Ifo Expectations New (July) (Thursday, 25 July, Week 30): The Ifo Expectations New sub-index provides insights into the business outlook for the coming months. In June, the expectations gauge went down to 89 from 90.4. A further decline would suggest that businesses are becoming more pessimistic about the future.
Consumer Sentiment:
Euro Area Consumer Confidence Flash (July) (Tuesday, 23 July, Week 30): The consumer confidence index is a key gauge of household sentiment. The consumer confidence indicator in the Euro Area rose by 0.3 points from the previous month to -14.0 in June 2024, the highest since February 2022 and in line with preliminary estimates. A decline in the index would point to a weakening consumer outlook.
Germany GfK Consumer Sentiment (August) (Tuesday, 23 July, Week 30): The GfK Consumer Climate Indicator for Germany dropped to -21.8 heading into July 2024 from a marginally revised -21.0 in the previous period, missing market forecasts of -18.9 and marking the first decline in five months. Both income expectations (8.2 vs 12.5 in June) and economic prospects (2.5 vs 9.8) were notably lower after rising in the prior four months. A further decline in the index would suggest that German consumers are becoming more pessimistic about the future.
Trade:
Euro Area Balance of Trade (June) (Tuesday, 16 July, Week 29): The trade balance is expected to remain in surplus. However, any narrowing of the surplus would be a sign of weakness in external demand. Euro Area recorded a trade surplus of 13887.70 EUR Million in May of 2024.
Germany Balance of Trade (May) (Tuesday, 16 July, Week 29): Germany's trade surplus rose to EUR 24.9 billion in May 2024 from a marginally revised EUR 22.2 billion in April, surpassing forecasts of EUR 21.1 billion. It was the largest trade surplus since January, as exports fell less than imports. A further narrowing of the surplus would be a sign of weakness in German exports.
The Euro-Area's economic situation is important because it is a major driver of global economic growth. The bloc is also a key trading partner for many countries, including the United States and China. For forex traders, understanding the economic outlook for the Euro-Area is crucial for assessing the potential impact on the euro.
The ECB's Tightrope Walk: Balancing Inflation and Growth
Monetary policy in the Euro-Area has been characterised by a cautious approach in recent months. The ECB has been gradually raising interest rates since July 2022 in an effort to bring inflation back to its 2% target. However, the central bank has also been mindful of the risks to economic growth from tighter monetary policy. The ECB cut interest rates by 25bps in June 2024, but the decision was seen as a tactical error by some policymakers as inflation subsequently ticked up again. The ECB has since reaffirmed its commitment to keeping policy rates sufficiently restrictive for as long as necessary to achieve its goals. However, the central bank has also stressed that it will continue to follow a data-dependent approach and will not pre-commit to a particular policy path. The ECB's July monetary policy statement noted that "The incoming information broadly supports the Governing Council’s previous assessment of the medium-term inflation outlook. While some measures of underlying inflation ticked up in May owing to one-off factors, most measures were either stable or edged down in June. In line with expectations, the inflationary impact of high wage growth has been buffered by profits. Monetary policy is keeping financing conditions restrictive. At the same time, domestic price pressures are still high, services inflation is elevated and headline inflation is likely to remain above the target well into next year."
The next five weeks will be crucial for determining the future direction of monetary policy. The ECB will be closely monitoring economic data releases, particularly for signs of whether inflation is moderating as expected. The central bank will also be assessing the impact of its June rate cut on economic growth and financial conditions. The market is currently pricing in a 64% chance of a rate cut at the ECB's September meeting. However, the outlook for monetary policy is highly uncertain and will depend on the evolution of the data. If inflation remains stubbornly high, the ECB may be forced to raise interest rates again, potentially supporting the euro. However, if the economy shows signs of weakening, the central bank may opt to cut rates further, potentially weighing on the euro. For forex traders, understanding the monetary policy outlook is crucial for assessing the potential impact on the euro.
Risks to the Euro-Area Outlook: Navigating a Turbulent Landscape
Top 3 Risks (Previous 5 Months):
The French Election Surprise (March-April 2024): The unexpected outcome of the French legislative elections, resulting in a hung parliament, has increased political uncertainty in France and raised concerns about policy paralysis. This has weighed on market sentiment and contributed to volatility in the euro.
Dissolution of the National Assembly by President Macron.
Early legislative elections held in June and July.
Formation of a fragile coalition government.
The Energy Price Shock (February 2022-Present): The surge in energy prices triggered by the war in Ukraine has had a significant impact on the Euro-Area economy, fueling inflation and dampening economic growth. The energy crisis has also increased uncertainty and weighed on market sentiment.
Russia's invasion of Ukraine.
Soaring prices for oil and gas.
Introduction of energy support measures by EU governments.
The ECB's Policy Pivot (June 2024): The ECB's decision to cut interest rates in June, despite signs of persistent inflation, has raised concerns about the central bank's commitment to price stability. This has contributed to volatility in the euro and increased uncertainty about the future direction of monetary policy.
25bps rate cut in June.
Subsequent uptick in inflation.
Mixed signals from ECB policymakers about the future path of interest rates.
Top 3 Risks (Next 5 Weeks):
The Inflation Conundrum (July-August 2024): Persistent inflation could force the ECB to raise interest rates again at its September meeting, potentially dampening economic growth and weighing on market sentiment. The ECB's June 2024 macroeconomic projections suggest that "Headline inflation is projected to move broadly sideways in the near term, before moderating further to levels close to target in the course of 2025." However, the projections also acknowledge that "Inflation could turn out higher than anticipated if wages or profits increase by more than expected. Upside risks to inflation also stem from the heightened geopolitical tensions, which could push energy prices and freight costs higher in the near term and disrupt global trade."
The German Slowdown (July-August 2024): A further weakening of the German economy, the Euro-Area's largest, would have a significant impact on the bloc's overall economic performance and could weigh on the euro. The HCOB Germany Manufacturing PMI has been below the 50.0 no-change mark for 17 consecutive months, indicating a prolonged contraction in manufacturing activity. The June 2024 sentix Economic Index for Germany also showed a decline in both the current situation and expectations components, suggesting a worsening economic outlook.
The Geopolitical Wild Card (July-August 2024): An escalation of geopolitical tensions, such as a further deterioration of relations between the West and China or Russia, could weigh on market sentiment and contribute to volatility in the euro. The ongoing war in Ukraine, the potential for increased trade tensions between the US and China, and the risk of further instability in the Middle East are all key geopolitical risks to monitor.
Conclusion and Action Points
The Euro-Area economy is facing a challenging outlook, with growth stalling amid weakening manufacturing activity, persistent inflation, and heightened geopolitical uncertainty. The next five weeks will be crucial for determining the future direction of the economy and the euro. Key events to monitor include the release of Q2 GDP data, July inflation data, and the ECB's September monetary policy meeting. Forex traders should also pay close attention to developments in the energy market, the geopolitical situation, and the outlook for fiscal policy.
Key Economic Events to Monitor:
Euro Area GDP Growth Rate QoQ Flash Q2 (Tuesday, 30 July, Week 31): A weaker-than-expected reading could weigh on the euro, while a stronger-than-expected reading could support the currency.
Euro Area Inflation Rate YoY Flash JUL (Wednesday, 31 July, Week 31): A higher-than-expected reading could increase pressure on the ECB to raise interest rates, potentially supporting the euro. A lower-than-expected reading could ease pressure on the ECB and potentially weigh on the euro.
ECB Monetary Policy Meeting (Thursday, 12 September, Week 37): The ECB's policy statement and President Lagarde's press conference will be closely scrutinised for clues about the future direction of monetary policy. A hawkish tone from the ECB could support the euro, while a dovish tone could weigh on the currency.
Action Points for Forex Traders:
Monitor economic data releases closely for signs of whether the Euro-Area economy is gaining or losing momentum.
Pay close attention to the ECB's communication for clues about the future direction of monetary policy.
Be mindful of the risks to the economic outlook, particularly from inflation, the German slowdown, and geopolitical uncertainty.
Consider using technical analysis to identify potential trading opportunities in the euro.
Sources:
European Commission: European Economic Forecast - Spring 2023, Communication on the 2023 Draft Budgetary Plans: Overall Assessment, Communication on economic policy coordination in 2021: overcoming COVID-19, supporting the recovery and modernising our economy, Communication: One year since the outbreak of COVID-19: fiscal policy response, Debt Sustainability Monitor 2022
European Central Bank: Monetary policy decisions and statement (18 July 2024), Eurosystem staff macroeconomic projections for the euro area (June 2024), The euro area bank lending survey (April 2024)
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