After a long, unfavourable period of low rates lasting almost six years, European banks have seen their interest margins and profitability improve overall with the rise in ECB rates in 2022 and 2023. As we now enter a period of falling rates, Laurent Quignon talks to us about their effects on the interest margins of European banks.
After becoming positive again in August 2024, the private sector credit impulse in the Eurozone continued to recover in September, hitting its highest level in nearly two years (November 2022). Among other factors, it contributed to the pleasant surprise in terms of the development of Eurozone GDP in the third quarter (+0.4% q/q after +0.3% in the first and +0.2% in the second). Credit impulse to non-financial corporations has recovered more quickly since dipping below credit impulse to households in autumn 2023, when the restrictive effects of monetary policy peaked. The impulse of lending to households remained slightly negative in September.
The gradual improvement in household confidence indices in the Eurozone (financial situation and purchase intentions), supported by falling inflation, is still not leading to a rebound in consumption. Retail sales have been stable for a year, even though a slight rise of 0.2% m/m was recorded in August. Motor vehicle sales, which often display a significant change from one month to the next, rose by 8.2% m/m in September, but were down to their lowest level in three years on a three-month moving average basis.
Growth in the Eurozone is expected to stabilise at 0.3% q/q in the second half of 2024, before picking up slightly in 2025, supported by the cycle of interest rate cuts. However, the difficulties in industry, highlighted by the deterioration in PMI indices in September, and the uncertainty about the Chinese economy, increase the downside risks to our forecasts. A more adverse scenario, in which the manufacturing sector drags the rest of the economy along with it, is not the preferred one at the time of writing. Although less pronounced, the differences in dynamism between countries and sectors are expected to continue into 2025.
In September, the U.S. Federal Reserve at last followed suit with the ECB and the Bank of England and cut its policy rates for the first time since March 2020. But the Fed marked its difference, favoring a significant 50-basis-point cut instead of a more gradual 25. At least on that point, the suspense is over. But the rest of the story has yet to be written.
The household savings rate in France has risen further, up from 17.6% of households' gross disposable income (GDI) in Q1 2024 to 17.9% in Q2 2024, according to the INSEE, i.e. 1 point more in a year. This is also an early sign of an upward trend underway in the Eurozone. While the figures for Q2 are not yet available, the Q1 figures pointed to a savings rate 3 points higher than its pre-COVID level (at 15.4%).
Historical relationships between economic data play a key role in shaping expectations. In the US, the Sahm rule is such an important stylised fact: when the recent increase in the unemployment rate reaches a certain threshold, a recession tends to follow shortly or has even already begun. The jobs report published early August showed that this critical value had been reached, triggering a drop in investor sentiment. At the Jackson Hole conference, Jerome Powell explained that the Fed’s focus is shifting to the labour market and brought an unambiguous message that the rate cutting cycle is to start in September
The difficulties in the Eurozone manufacturing sector are intensifying. Industrial production fell again in May, by -0.6% m/m (-0.8% m/m for the manufacturing index). The deterioration in the PMI indicators for the euro area in June does not bode well for Q3, with a fall in the manufacturing index (-1.5 points to 45.8) and a decline in all the subcomponents (production, employment, new orders, stocks of purchases, delivery times). The input price index (which is not included in the calculation of the aggregate manufacturing index) is back above the expansion zone for the first time since February 2023. This is consistent with the trend in producer prices, for which the monthly decline has been slowing for several months and is now close to zero
The first cut in policy rates by the European Central Bank on 6 June came as no surprise, as the committee members had largely prepared the ground ahead of the decision. The timing and scale of future easing is more uncertain, given the continuing strong pressure on wages, high inflation in services, and the resurgence of tensions in global shipping. We expect two further interest rate cuts in 2024, at a pace of one per quarter (September and December).
In recent weeks the guidance from several ECB Governing Council members had become increasingly clear that the June meeting would see its first rate cut in this cycle. Against this background, not acting was out of the question, despite the uptick in the latest inflation data.
Following the first rate cut at the June meeting of the ECB, the focus has now shifted to the timing and speed of further reductions in the deposit rate. The guidance is vague: decisions will be data-dependent. For investors, estimating policy rules -the relationship between past decisions and inflation and other relevant variables- has merits to get a better understanding. Such a rule shows the key role played by the difference between observed inflation and the inflation target. However, there are important caveats. The estimated rule implies a very slow adjustment of the deposit rate, which is difficult to justify when the ECB is in easing mode
Speaking at a joint press conference in Germany on Tuesday, 28 May 2024, the French President and German Chancellor expressed their desire to create a “European savings product” to “bolster Europe’s competitiveness and growth”. This political will follows on from the Letta[1] and Noyer[2] reports and statements made by the French Minister of the Economy. It’s a new approach to getting Capital Markets Union back on the rails.
The ECB’s meeting on 6 June, as well as the statement and press conference that will follow, are very much awaited, not because the outcome is uncertain, but because it should mark the start of the ECB’s rate-cutting cycle. Some points to note.
If there could still be any doubt, Philip Lane's latest statements will, on the face of it, confirm a first cut in the ECB’s policy rates at the next monetary policy meeting on 6 June. The current trend in euro-zone inflation is giving space for the ECB to initiate monetary easing, even though new upward pressure on prices are emerging. Inflation fell marginally in April from 2.43% y/y to 2.37% y/y, while core inflation decreased more sharply from 2.95% y/y to 2.66% y/y. The likely return of a positive contribution from the energy component in May (after twelve months in negative territory), an upward momentum in services prices (the 3m/3m annualised rate rose back above 5%) and annual growth in negotiated wages, which were on the rise once again in Q1 (4
The publication of the second flash estimate of GDP for the euro area on Wednesday 15 May did not bring any significant change compared to the initial estimate. However, it confirms an encouraging recovery in economic activity. Real GDP in the euro area rebounded by 0.3% q/q, as announced in the previous report, an increase that ends two quarters of slight contraction (-0.1% q/q for Q3 2023 and Q4). Growth was driven by the Baltic economies (Latvia and Lithuania at +0.8% q/q), as well as by the southern European economies, notably Spain and Portugal, which saw their activity expand by 0.7% in Q1, at the same pace as in the previous quarter. Growth strengthened slightly in France (+0.2% q/q) and rebounded in Germany (+0.2% q/q), while Italy was in line with the euro area average.
Since the adoption of the European Green Deal on 11 December 2019, European climate strategy has stepped up. Far from paralysing its climate action, the health crisis was the backdrop for the adoption of NextGenerationEU. This recovery plan has mobilised considerable resources to meet the European Union’s needs in terms of climate and digital transition, healthcare and education. While its implementation is only halfway through, the first positive effects can already be observed. Other mechanisms (including REPowerEU, the carbon border adjustment mechanism and the Critical Raw Materials Act) have been added to this plan to respond to the new challenges that have arisen since the Covid-19 pandemic and the war in Ukraine (supply security, energy dependence)
In the first quarter, real GDP growth in the United States and the Eurozone was almost on a par, at a quarterly rate of 0.4% for the United States and 0.3% for the Eurozone, according to initial estimates. However, on a year-on-year basis, the situation remains very much to the United States’ advantage, with growth of 3% when Eurozone growth is only 0.4%.
In line with previous months, the recovery in the private sector credit impulse continued in the first quarter of 2024, after the dip seen in the third quarter of 2023. This said, the recovery was slightly slower than at the end of 2023 and the overall trend is still negative. Developments in lending to business are traditionally more volatile over the cycle than those in lending to households. Recent ones have not deviated from this rule: in the autumn of 2023, at a time when the effects of the tightening of monetary policy were at their strongest, the impulse of lending to households did not fall as far, in absolute terms, as that for lending to businesses. Conversely, its recovery since then has been less vigorous
After two years – 2021 and 2022 – of significant improvement linked to the post-Covid recovery in activity, 2023 marked a halt in the recovery of public finances in the euro area. According to preliminary results published on Monday by Eurostat, the public deficit narrowed in 2023 by only 0.1 point of GDP, to 3.6%. The primary deficit also fell by the same magnitude, to 1.9% of GDP.
Economic activity in the eurozone is expected to gradually pick up over the course of 2024, buoyed by improving household purchasing power and falling interest rates. However, the industrial sector in the eurozone is facing major structural problems, which will not (or will only slightly) be addressed by lowering the ECB’s policy rates. The ramp-up of the EU’s recovery fund should, in theory, enable southern eurozone countries, which are the main recipients, to outperform again in 2024. However, so far, its effects have been relatively limited and the implementation problems, as highlighted in a recent European Commission report, will not go away completely this year.
The S&P Global manufacturing PMIs for the month of March point towards a pickup in economic momentum in most countries. In the Eurozone, the improvement is strong, especially in manufacturing and to a lesser degree in services. Momentum is slow however in terms of employment. In the US, the recent pickup in manufacturing sentiment is also strong compared to history. Against the background of these and other strong data, Fed officials have insisted on the need for caution in cutting rates, all the more so considering that the pace of disinflation has clearly slowed. The US soft landing view is increasingly being challenged and ‘no landing’ is put forward as an alternative
Disinflation in the euro zone continues to buoy household confidence. The European Commission index rose by 0.6 points to 14.9 points in March, according to the flash estimate. This is its highest level since February 2022 and the start of the war in Ukraine.
Monetary anchoring is one of the main arguments put forward by central banks to justify an eponymous digital currency. According to supporters of the digital euro, a reduction in the use of paper money or even its disappearance would be the natural next step and result in the creation of a digital form of central bank currency that would be the only guaranteed way of keeping the currency anchored in the digital era. Nothing could be less obvious.
With zero growth in the last quarter of 2023, the Eurozone has narrowly escaped recession, but economic activity is still hanging by a thread. Over 2023 as a whole, the increase in real GDP just reached 0.5%, and the carry-over effect for 2024 is null, as a result of a second half that was even weaker than the first one. Nevertheless, our Nowcast currently indicates growth of 0.3% q/q in Q1 2024, which is higher than our December forecast.
There is a broad consensus amongst forecasters that Eurozone quarterly growth in real GDP will gradually pick up over the year on the back of a further decline of inflation, cuts in official interest rates, investments in the energy transition and those related to NextGeneration EU. Foreign trade may also play a role. Survey data of the European Commission and S&P Global have improved since the autumn of last year but their level remains below the historical average. Based on historical relationships, their positive momentum -recent observations are better than those 3 months ago- increases the likelihood that GDP growth in the first quarter will be better than in the final quarter of 2023.
