Despite the positive momentum it would be premature to say that the recovery has started in the Eurozone, but at least we are moving in the right direction.
The ECB’s tightening of monetary policy between the summer of 2022 and September 2023 continued to have its effects on euro zone bank lending in the fourth quarter of 2023. However, in the absence of a further turn of the screw since September 2023, these effects have not intensified further. Outstanding bank loans to the private sector even accelerated slightly, year-on-year, in the fourth quarter (up 0.5% in December 2023 compared to 0.3% in September) in line with GDP (up 0.1% in the fourth quarter from 0.0% in the third). The credit impulse remains negative but increased slightly for the first time since the ECB began to increase rates in July 2022.
Eurozone activity is expected to pick up moderately in 2024, buoyed by the fall in inflation and the start of a cutting cycle of policy rates, which, according to our forecasts, will take place in April. The labour market continues to surprise on the upside. However, industrial production is falling sharply and remains highly exposed to escalating tensions in the Red Sea and the repercussions on shipping and supply chains. 2024 will see a number of national parliamentary and presidential elections (Finland, Portugal, Belgium, Austria) and the European elections (6 to 9 June), which are likely to redraw the political landscape in the region and the balance of power within the European Parliament.
The eurozone narrowly escaped economic contraction in the last quarter of 2023, but the picture is mixed among countries. According to preliminary figures from Eurostat, real GDP in the euro area remained stable in Q4, following a slight decline of 0.1% q/q in Q3. Quarterly growth surprised to the upside in Spain (+0.6%), Italy (+0.2%), while the data for France (0.0%) and Germany (-0.3%) were in line with the consensus. The largest decline in the euro area came from Ireland (-0.7%) while Portugal’s growth rose the most (+0.8%).
Because of its significance and its many connections with the real and financial spheres, the residential property sector plays a central role in the economic cycle. The acceleration in property prices in the eurozone, which began in 2014, the year in which the monetary bloc emerged from recession, intensified after the "Great Lockdown" of 2020, peaking at almost 10% year-on-year in the first quarter of 2022. The tightening of monetary policy by the European Central Bank, unprecedented in its scale and speed, seems to have put a halt to this progress, although at this stage there are significant differences between countries. Economies where the property market had withstood the subprime crisis better now appear to be in greater difficulty in the face of tighter credit conditions
The end of the year is shaping up to be a difficult one for the eurozone, as displayed by the flash PMI indicators for December. The composite index, fell by 0.6 points to 47, and remains below the threshold of 50 (in contraction territory) for the seventh month in a row. The employment index has not plummeted, but has been gradually declining since April, reaching 49.6 in December, its lowest level in three years. At 6.5% in October, the unemployment rate in the eurozone stabilised at a historically-low level, which is increasingly looking like a floor. We expect the jobless rate to rise slightly over the next few months, in line with current trends in the PMI indices. The unemployment rate for young people (under 25) has already risen by one percentage point in six months, to 14
The ECB's latest macroeconomic projections show fairly marginal downward revisions to inflation (headline and core) and economic growth for both 2023 and 2024, compared to the September forecast. With real GDP growth now foreseen at 0.6% on average this year and 0.8% next year, the ECB's projections are slightly higher than ours, currently at 0.5% and 0.6% respectively.
Inflation remains high but, judging by the latest figures published for the Eurozone, it is much less so and, at first glance, it is no longer very far from the 2% target. Of course, there is still some way to go; the uncertainty relates in particular to how fast the “last mile” of disinflation will be covered, before reaching the 2% target. It is to be expected to be slow rather than quick, partly because favorable base effects on energy prices will play less.
Recent business surveys suggest that the cyclical environment in the Eurozone, Germany and France is stabilising but it would be premature to call it a bottoming out. Such a positive development seems unlikely in the near term. Monetary policy is expected to remain tight for some time and part of the effect of the past rate hikes still needs to manifest itself. Bank lending policy is expected to remain cautious because of rising credit risk in a stagnating, high interest rates economy and credit demand from firms and households is weak. Significant progress in terms of disinflation seems to be a necessary condition for a lasting upturn in the economic outlook.
Without falling significantly, confidence indicators for the euro area confirm the current phase of stagnation, which is expected to continue into Q4 2023. According to the flash estimate, the composite PMI edged up by 0.6 points to 47.1 in November, while the European Commission's Economic Sentiment Indicator fell slightly in October, down by 0.1 points to 93.3 (its lowest level in three years). Despite the current deceleration in inflation (from 4.3% y/y in September to 2.9% y/y in October in harmonised terms) and an unemployment rate that is close to its lowest ever (6.5% in September), household confidence is not recovering, against a still difficult backdrop in terms of purchasing power
The tightening of euro-zone monetary policy, which began in July 2022 and carried on until September 2023, continued to curb demand for loans and dampen economic activity in the third quarter of 2023. The initial effects on core inflation have also been apparent since the end of the summer.
The September data show that disinflation continues in the Eurozone. Moreover, this development is broad-based and for more than half of the HICP items, 3-month inflation is below the ECB’s target expressed on an equivalent basis. This increases the likelihood that the decline in inflation continues to spread through the Eurozone economy. However, despite the progress, inflation remains well above target. This implies that, if going forward monthly core inflation would correspond to the ECB’s target (expressed as a monthly number), it would still take until September next year for it to get back to 2% in terms of annual inflation
The inflation situation, in the Eurozone, is cooling. Added to this good news is the surprising continued drop in the unemployment rate (6.4% in August compared with 6.7% at the beginning of the year). But these positive developments are offset by a cooling also being seen in the European Commission Economic Sentiment Indicator (ESI). Given the weakness of confidence surveys, real GDP growth – only just positive in Q1 and Q2 2023 (+0.1% q/q each quarter) – is expected to be close to zero. We expect nil growth in both Q3 and Q4 2023, a forecast aligned with our nowcast estimate, also at zero.
Eurozone company surveys (PMI, European Commission) continued to deteriorate throughout the summer, although a slight improvement was observed in September for the PMI. The rise in policy rates by 25 basis points in September – the last one according to our forecast – will amplify this phenomenon. We do not expect a recession in the euro zone as a whole in 2023, but moderate growth at 0.5%, mainly due to a favourable carry-over effect in 2022. After a slightly positive first semester, eurozone activity is likely to stall in the second semester. Significant growth differentials are expected between the Member States.
The impact on financial expenses of rising interest rates - the result of the European Central Bank tightening its monetary policy - is very mixed, depending on the euro zone country. The impact depends on the proportion of variable-rate loans in outstanding amounts, and also on levels and changes in the amounts borrowed.
Inflation in the Eurozone is declining and recent survey data point towards a possible stabilisation of economic activity. However, inflation remains well above target and business sentiment has reached a (very) low level. Based on the historical relationship, the current level of the S&P Global composite PMI and the economic sentiment index of the European Commission point towards, at best, a stagnation of activity in the coming months. Whether growth will turn out to be higher or lower will largely depend on how the environment will change. Downside risks are the delayed effect of past monetary tightening and, to a lesser degree, the recent rise in energy prices and the weaker growth environment in China
The ECB has increased its key rates by 450 basis points since July 2022. This is the sharpest tightening of monetary policy since the creation of the euro area in 1999. This tightening has been transmitted to lending rates and bank deposit rates. This is in line with the objectives of monetary policy to slow global demand and to bring back inflation to a level of 2%.
After proving resilient, the PMI surveys for the services sector are deteriorating more significantly. The indicator lost 3 points in August to 47.9, the lowest level seen since February 2021. In particular, the sub-indices relating to employment and new businesses creation fell significantly.
In its latest meeting, the ECB Governing Council decided to tighten policy further, bringing the deposit rate to 4.00%. It considers that the current level of official rates, if maintained for a sufficiently long duration, will make a substantial contribution to bring inflation back to the 2% target in a timely way. Financial markets rallied, expressing a conviction that policy rates have reached their cyclical peak. The focus is now shifting to how long they will stay at this level and what will be the pace of easing thereafter. The ECB’s reaction function depends on the assessment of the inflation outlook in the light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission
The effects of monetary policy tightening on the distribution of bank credit in the eurozone, which have been obvious since Q4 2022, further intensified during Q2 2023. The private-sector credit impulse has fallen constantly since autumn 2022. It dropped below zero in February 2023 and hit, in June 2023, its lowest level since 2010. The non-financial company credit impulse has experienced its biggest downturn since 2008, falling from its historic summer 2022 highs into negative territory in the space of eight months (April 2023). Despite declining less overall, household-credit impulse went into the red earlier on (November 2022), as it was starting out at a lower level.
The latest quarterly survey of the European Commission of factors limiting the production of companies shows that few services companies mention insufficient demand as an issue. The score of the financial factor is on the rise but remains below average. Supply side factors remain at exceptionally high levels. A priori, one would expect that the combination of strong demand and constrained supply will influence the price setting behaviour of companies. However, regression analysis shows that these factors only explain a small part of the fluctuation in services inflation. Wage growth and the input prices PMI do a far better job. They will need to see a significant decline for services inflation to converge to 2.0%. This will take time.
Economic activity in the eurozone is showing clearer signs of weakening, and our Nowcast now foresees a stagnation in real GDP in the second quarter of 2023. Retail sales were stable during the first two months of Q2. Survey data also offers little reassurance and seems to indicate a possible relapse in activity in Q3 which we currently estimate at -0.1% q/q: the composite PMI index deteriorated significantly in June, falling below the threshold of 50, to 49.9. The manufacturing sector index fell further into contraction and is now at levels comparable to those seen during 2020, in the midst of the pandemic.
Each quarter, the European Commission asks companies about the factors limiting their production: insufficient demand, supply constraints (labour market, shortage of material and/or equipment) and a financial factor. The survey can help in getting a better understanding of the inflation drivers. A quantitative model of producer price inflation suggests that the pace of disinflation will be slow considering that, contrary to the demand factor, which is close to its long-term average, supply factors in industry continue to act a constraint on production far more than is the case normally. Although the analysis was conducted in terms of producer price inflation, given its close relation with consumer price inflation (HICP) in the Eurozone , the conclusions are also relevant for the latter.
Since last weekend, the summer holiday season has really started and based on media reports as well as business surveys, activity in the tourism sector should be strong. Pent-up demand probably plays an important role, considering that tourism expenditures and nights spent in hotels are still below pre-Covid-19 levels. Another factor is the strong rebound in consumer confidence on the back of a more positive assessment of the economic outlook and the personal financial situation as well as a more benign view on the inflation outlook. The stock of excess savings accumulated during the lockdown may also play a role as well as changes in the allocation of household spending. Going forward, the outlook will probably be more challenging.
The eurozone entered a technical recession in Q1 2023, with Eurostat having revised lower its estimate of quarterly GDP growth for Q1 from +0.1% to -0.1%, i.e. the same pace of contraction as in Q4 2022. These results do not profoundly change our assessment for 2023: weak or slightly negative economic activity, quarter-on-quarter, although growth for 2023 as a whole should be more positive thanks to the favourable carry-over growth effect. Our current forecasts are based on a terminal refinancing rate of 4.5%, which would be reached at the monetary policy meeting on 14 September. Nevertheless, the scenario of harsher tightening cannot be completely ruled out, given the ongoing inflationary momentum and still high inflation generalisation indices.
