Euro Area Macroeconomic Outlook: Navigating a Gentle Breeze Towards Recovery
Key risk events in the next five weeks include the NATO Summit, French Parliamentary Elections, and FOMC Announcement.
Tuesday, 02 July, Week 27: Euro Area economy faces recovery amid persistent inflation. ECB's rate cut balances growth and price stability. Upcoming political events and global developments add uncertainty. This report analyses macroeconomic landscape, fiscal and monetary policy, economic indicators, and market risks to guide forex traders.
Fiscal Policy
Fiscal policy, the government's use of spending and taxation, significantly impacts the economy by influencing economic activity, inflation, and financial markets.
Over the past five months, the Euro Area's fiscal policy has been characterised by a notable tightening, primarily driven by the withdrawal of energy and inflation support measures implemented in response to the energy crisis. This fiscal consolidation is projected to continue over the next five months, albeit at a more gradual pace. The Euro Area budget deficit, which reached 3.6% of GDP in 2023, is expected to narrow to 3.1% in 2024 and fall below the 3% of GDP reference value in 2025. The debt-to-GDP ratio, standing at 88.5% at the end of 2023, is projected to stabilise around 88.6% over the projection horizon. This commitment to fiscal discipline is likely to be viewed favourably by financial markets, but could create a slight headwind for economic growth in the near term. The ECB, in its June 2024 Monetary Policy Statement, acknowledged the role of fiscal policy in supporting the economic recovery, stating that "National fiscal and structural policies should aim at making the economy more productive and competitive, which would help to raise potential growth and reduce price pressures in the medium term."
Economics
Economics, the study of resource allocation, offers a framework for understanding economic growth, inflation, employment, and trade, influencing monetary policy and financial markets.
The Euro Area economy has been grappling with a confluence of challenges over the past five months, including high inflation, rising interest rates, and geopolitical uncertainty stemming from the war in Ukraine and tensions in the Middle East. Despite these headwinds, the economy has shown resilience, with the labour market remaining strong and consumer spending holding up relatively well. The outlook for the next five months remains uncertain, with the ECB's June 2024 staff projections forecasting GDP growth of 0.9% in 2024, 1.4% in 2025, and 1.6% in 2026. Inflation is projected to moderate to 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026. However, risks to the outlook are tilted to the downside, with a weaker global economy, an escalation in geopolitical tensions, and stronger-than-expected effects of monetary policy tightening all posing potential threats.
Economic Growth
GDP Growth Rate: 0.3% in Q1 2024 (quarter-on-quarter). The ECB forecasts growth of 0.9% in 2024, 1.4% in 2025, and 1.6% in 2026.
Key Drivers: Consumer spending, net trade, and government investment.
Assessment: The Euro Area economy emerged from stagnation in Q1 2024, recording positive GDP growth after five quarters of either flat or negative growth. This suggests a gentle tailwind is beginning to propel the economy forward. However, the pace of growth remains modest, and the outlook is clouded by downside risks, including a potential slowdown in global economic activity and persistent geopolitical uncertainty.
Labour
Unemployment Rate: 6.4% in May 2024 (record low).
Employment Growth: 0.3% in Q1 2024 (quarter-on-quarter).
Assessment: The Euro Area labour market continues to be a source of strength, with the unemployment rate at a record low and employment growth remaining positive. This tight labour market is providing a tailwind for consumer spending, as rising wages support household incomes. However, it is also contributing to inflationary pressures, as businesses face higher labour costs.
Price Changes
Inflation Rate (HICP): 2.5% in June 2024 (annual rate). The ECB forecasts inflation of 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026.
Core Inflation (HICPX): 2.9% in June 2024 (annual rate).
Assessment: Inflation in the Euro Area has moderated from its peak, but remains well above the ECB's 2% target. Core inflation, in particular, is proving sticky, suggesting that underlying price pressures persist. This inflationary headwind is eroding consumer purchasing power and complicating the ECB's monetary policy decisions.
Trade
Balance of Trade: €15.0 billion surplus in April 2024.
Exports: Increased by 14.0% year-on-year in April 2024.
Imports: Increased by 1.8% year-on-year in April 2024.
Key Product Categories: In the first four months of 2024, the EU, which includes the Euro Area, saw significant export increases in machinery & vehicles (+11.7%), chemicals (+25.1%), and food & drink (+9.2%). Imports declined, mainly due to a fall in energy products (-9.7%), raw materials (-22.9%), and machinery & vehicles (-2.4%).
Assessment: The Euro Area's trade balance remains in surplus, reflecting strong export performance. However, the outlook for trade is subject to global economic conditions and geopolitical developments. A slowdown in global demand could create a headwind for exports, while escalating trade tensions could disrupt supply chains and increase import costs.
Monetary Policy
Monetary policy, the management of interest rates and money supply by a central bank, is a powerful tool for influencing economic activity and inflation. It can stimulate or restrain borrowing and spending, affect exchange rates, and impact financial market conditions.
The ECB has been gradually tightening monetary policy since December 2021 to combat high inflation. This has included raising interest rates and reducing its asset purchase programmes. However, in June 2024, the ECB lowered its key interest rates by 25 basis points, marking a potential shift towards a less restrictive stance. This move suggests that the ECB is acknowledging the headwinds facing the economy and is seeking to provide some support for growth. However, the ECB remains committed to bringing inflation back to its 2% target, and further policy adjustments will depend on incoming data. The ECB, in its June 2024 Monetary Policy Statement, emphasised its data-dependent approach, stating that "In particular, our interest rate decisions will be based on our assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission."
Market Risk
Market risk encompasses the potential for losses arising from changes in market prices, interest rates, exchange rates, and other financial variables. It can affect businesses, investors, and the broader economy through its impact on asset values, borrowing costs, and investment decisions.
Significant Risk
US Presidential and Legislative Elections (November 5th, 2024): The outcome of the US elections will have profound implications for the global economy and financial markets. Uncertainty surrounding the election could lead to heightened volatility in the Euro, particularly against the US Dollar.
NATO Summit (July 9th-11th, 2024): The NATO summit is expected to focus on the ongoing conflict in Ukraine and relations with Russia. Any escalation in tensions or significant announcements regarding military aid could impact the Euro and global risk sentiment, potentially leading to a flight to safe-haven currencies like the Japanese Yen and Swiss Franc.
China's Third Plenum of the 20th Central Committee (July 15th-18th, 2024): This meeting will be crucial for determining China's economic direction. Announcements regarding stimulus measures, trade policies, or structural reforms could significantly impact global markets, including commodity prices, and potentially affect the Euro.
Minor Risk
French Parliamentary Elections (July 9th-11th, 2024): The outcome of the French elections could impact the Euro, particularly if it leads to political instability or significant policy shifts. A strong showing by Eurosceptic parties could create headwinds for the Euro.
UK General Election (July 4th, 2024): A Labour victory could lead to closer EU ties and potentially strengthen the Euro against the Pound in the long term. However, initial uncertainty surrounding the election outcome could weaken the Euro.
NATO Summit (July 9th-11th, 2024): As mentioned above, the NATO summit could impact the Euro depending on the outcome of discussions regarding Ukraine and Russia.
FOMC Announcement (July 31st, 2024): The Federal Reserve's policy announcement will be crucial for the US Dollar. A hawkish stance, suggesting a continuation of interest rate hikes, could strengthen the Dollar and weaken the Euro.
Conclusion
The Euro Area economy is navigating a complex environment, with both tailwinds and headwinds influencing its trajectory. While GDP growth has returned to positive territory, inflation remains a concern, and the outlook is subject to significant uncertainty. The ECB's recent rate cut suggests a cautious approach to balancing growth and price stability, but further policy adjustments will depend on incoming data and the evolution of global economic and geopolitical conditions. Forex traders should closely monitor key economic indicators, political events, and central bank communications to assess the shifting winds and adjust their trading strategies accordingly.
References
European Central Bank
EUROSTAT
Trading Economics
Bloomberg
Federal Reserve
Bank of England
Bank of Japan
Bank of Canada
Statistics Canada
Office for National Statistics (UK)
OECD
S&P Global
European Commission