German Angst, Mixed Signals, and the ECB's Dilemma: The Euro's Uncertain Path
Wednesday, 18 September, Week 38
This past week has been a volatile one for the euro. The ECB's recent rate cut and its reluctance to signal future intentions have created uncertainty, particularly in light of mixed economic signals from the Eurozone. The release of the September German ZEW Economic Sentiment Index, showing a significant decline, added to these concerns.
Market Themes
Dominant Theme: ECB's Monetary Policy Decisions Keep Traders on Edge
Uncertainty surrounding the European Central Bank's (ECB) monetary policy has been the dominant theme in euro markets for the past month. The ECB is juggling the challenges of persistent inflation and a fragile economic recovery, all against a backdrop of geopolitical tensions and a global slowdown.
The ECB's recent rate cuts, including the move in June to lower the deposit facility rate to 3.5%, indicate a more accommodative stance. However, the lack of clear forward guidance has left traders speculating about potential future cuts, injecting a dose of volatility into the euro.
Here's a timeline of recent events highlighting this theme:
September 13th, 2024 (Week 37): The EUR briefly climbed above $1.100 following the ECB's latest rate cut, but the lack of clarity on future policy actions kept the market uneasy.
September 10th, 2024 (Week 37): The EUR slipped to around $1.070, reflecting a cautious mood in European markets as traders awaited the ECB's policy decision.
September 2nd, 2024 (Week 36): Preliminary figures for August revealed a drop in Eurozone inflation to a three-year low of 2.2%, increasing the odds for another potential ECB rate cut and pushing the euro lower.
Emerging Theme: Weak German Sentiment and Mixed Signals Compound Eurozone Concerns
Adding to the uncertainty surrounding the euro has been a mix of economic signals from the Eurozone. The release of the September German ZEW Economic Sentiment Index, falling short of expectations, further amplified these anxieties.
Here are some events that illustrate this emerging theme:
September 17th, 2024 (Week 38): The German ZEW Economic Sentiment Index tumbled to 3.6, an 11-month low, significantly below the forecast of 17.6. This unexpected drop in sentiment, influenced by concerns about a weakening German economy, rising corporate insolvencies, and potential job losses, has cast a shadow on the Eurozone's overall economic outlook.
September 13th, 2024 (Week 37): Eurozone industrial production for July disappointed, adding to the sense of unease about the strength of the economic recovery.
September 4th, 2024 (Week 36): While slightly revised downward, the HCOB Eurozone Composite PMI remained in positive territory, offering a glimmer of hope for the EA economy.
September 2nd, 2024 (Week 36): The Eurozone manufacturing PMI confirmed a continued contraction in the manufacturing sector, highlighting the uneven nature of the recovery.
The Geopolitical Landscape
Geopolitics continue to weigh heavily on the Euro Area, impacting both the region’s economy and the euro. The war in Ukraine, the energy crisis it triggered, and the assassination of Hamas leader Ismail Haniyeh in Tehran have all had a significant impact on the EA's outlook.
The war in Ukraine has disrupted energy markets, supply chains, and fueled inflationary pressures across the Eurozone. The assassination of Haniyeh has further heightened geopolitical risks, adding to the uncertainty surrounding the region’s future.
As the IMF noted in its July 2024 World Economic Outlook:
"The war in Ukraine has had a profound impact on the global economy, disrupting supply chains, fueling inflation, and exacerbating geopolitical tensions. The conflict has also highlighted the importance of energy security and the need for diversification of energy sources."
The geopolitical landscape remains fluid, with the war in Ukraine showing no signs of ending and the potential for further escalation. The situation in the Middle East remains delicate after Haniyeh’s assassination, with the potential for further regional instability.
These geopolitical tensions are likely to continue to impact the Eurozone economy and the euro. Persistent energy price volatility, supply chain disruptions, and increased uncertainty could dampen economic growth and keep inflation elevated.
Fiscal Policy
Euro Area governments are under pressure to balance support for their economies with the need for fiscal responsibility. They are tasked with addressing the economic impact of the energy crisis and rising public debt levels, all while trying to foster a sustainable recovery. The reformed EU fiscal framework, set to be implemented from 2025, will be key in shaping the region's fiscal future.
Euro Area governments responded to the pandemic and the energy crisis with a series of support measures, including fiscal stimulus, energy subsidies, and refugee aid. While these interventions were necessary, they have also led to elevated public debt levels in many countries, raising concerns about long-term fiscal sustainability.
The new EU fiscal framework, adopted this year, attempts to balance these competing demands. It aims to provide governments with flexibility while encouraging fiscal discipline and ensuring debt sustainability.
The upcoming month will be crucial for fiscal policy in the Euro Area. Governments will need to carefully manage spending and implement the new framework while demonstrating a commitment to fiscal responsibility. The success or failure of these efforts will undoubtedly influence the ECB's monetary policy decisions.
Economic Fundamentals
The Eurozone economy continues to send mixed signals. Growth has slowed in 2024, and the outlook remains clouded by external and internal factors. Inflation has eased from its 2023 peaks, but core inflation remains elevated, making it difficult for the ECB to achieve price stability.
Recent economic data reflects this mixed picture. The final Q2 GDP figures, released on August 7th, confirmed a growth rate of 0.2%, highlighting the slowdown. The final August CPI data, released on August 30th, showed headline inflation falling to 2.2%, a three-year low. However, core inflation remained at 2.8%, indicating persistent underlying price pressures.
Adding to the anxieties was the September German ZEW Economic Sentiment Index, released on September 17th, which plummeted to 3.6, its lowest level in eleven months. This sharp decline, significantly below market expectations, reflects growing pessimism about the German economy and casts a shadow over the Eurozone's prospects.
The economic outlook for the EA in the upcoming month remains uncertain. The war in Ukraine, the energy crisis, and the global economic slowdown continue to weigh on the region's performance. The ECB's monetary policy decisions, and the fiscal choices made by EA governments, will also play a key role in shaping the economic trajectory.
Monetary Policy
The European Central Bank (ECB) has been navigating a challenging economic landscape. It initially responded to high inflation with a series of rate hikes, starting in July 2022. But this year has seen a shift to a more accommodative policy stance, with two rate cuts implemented, the most recent on September 12th, bringing the deposit facility rate down to 3.5%.
However, the ECB has opted to hold back on providing clear forward guidance regarding future policy moves, instead maintaining a data-dependent, meeting-by-meeting approach. This approach, while offering flexibility, adds to the uncertainty in the market.
The ECB’s September 12, 2024 Monetary Policy Statement emphasised this flexible approach:
"The Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its 2% target over the medium term and to preserve the smooth functioning of monetary policy transmission."
The coming month will be a crucial one for the ECB. The direction of inflation, especially following the release of the final August inflation figures, will be a key consideration for the central bank. Upcoming economic data releases will shed further light on the Eurozone's economic performance, influencing the ECB’s next move. Additionally, the central bank will need to assess the fiscal policies being implemented by EA governments and weigh the potential impact of geopolitical developments.
Macroeconomic Outlook
The macroeconomic outlook for the Euro Area (EA) remains unpredictable as a confluence of factors – including the ECB's monetary policy, EA governments' fiscal choices, the geopolitical climate, and the global economic outlook – influence the region's trajectory.
The war in Ukraine, the lingering energy crisis, and a sputtering global economy are all headwinds for the Eurozone. These factors are also contributing to inflationary pressures, further complicating the situation for the ECB.
The coming month will be a pivotal one for the EA. The ECB's interest rate decisions, EA governments' fiscal policy choices, and any shifts in the geopolitical landscape will all shape the region's economic future.
Key Economic Indicators to Watch
Germany GfK Consumer Climate (Leading Indicator) is scheduled for release on Thursday, September 26th (Week 39). The forecast is -17.90. An improvement in consumer sentiment in Germany, the Eurozone's economic powerhouse, could boost the euro. Conversely, a further decline in consumer confidence could signal ongoing weakness in the German economy and weigh on the EUR.
Euro Area Economic Sentiment Indicator (Leading Indicator) is due on Friday, September 27th (Week 39). The forecast is 95.6. An actual reading that aligns with this forecast would be a positive sign for the euro, as it would indicate a continued positive outlook for the Euro Area's economy. However, a weaker-than-expected reading could indicate that economic sentiment is deteriorating, potentially putting pressure on the EUR.
Euro Area Unemployment Rate (Lagging Indicator) is due on Wednesday, October 2nd (Week 40). The forecast is for a steady rate of 6.50%. A rate in line with or below this forecast would point to a robust labour market in the Euro Area, offering some support for the EUR. A rise in unemployment, however, could signal further weakness in the EA economy and pressure the EUR.
Sources
This report is based on information compiled from a variety of authoritative sources, including:
European Central Bank
European Commission
Eurostat
Federal Statistical Office, Germany
INSEE, France
Trading Economics
Bloomberg
Reuters
OECD
IMF
GfK Group
Ifo Institute
Centre for European Economic Research (ZEW)
S&P Global
Ministère de l'Économie et des Finances, France
Bundesagentur für Arbeit, Germany
DARES, France
Newsquawk
Stratfor Worldview