The Conference Board Economic Forecast for the European Economy

Weaker business confidence and more cautious household spending cloud Europe’s growth recovery.

Underlying weaknesses pose risks to Europe’s economic rebound. The Euro Area economy expanded by more than expected in H1 2024, but it has lost momentum more recently. Business activity, as captured by the composite Purchasing Managers’ Index (PMI), declined from a mildly positive 50.6 in August to a pessimistic 48.9 in September. Weak global demand weighed further on factory output, while activity in the bloc’s dominant services sector slowed down considerably as the positive economic impact from the Olympics waned. Falling investments linked to high levels of geopolitical uncertainty and still restrictive monetary conditions will continue to put pressure on business activity. On a positive note, consumer confidence recovered further in September, reaching its highest level since early 2022, increasing hopes of private consumption supporting further the economy in the near-term. Caution though is needed. Notwithstanding improvements in sentiment, elevated household savings rates in the EA suggest any consumption-led recovery is likely to be more moderate than what we had anticipated. To sum up, while we still see the EA economy expanding in H2 2024, this is now likely to happen at a slower pace than in H1. As a result, we expect 2024 growth in the Euro Area to average 0.7%. Looking further into 2025, output growth should pick up pace, as monetary conditions become less restrictive, real incomes improve further and global demand recovers.

Germany now appears more likely to fall into a technical recession in Q3. Incoming data over September and early October confirm that Germany’s grim economic outlook has no end in sight. According to PMI, manufacturing activity in Europe’s largest economy sank deeper into contraction, with export orders for goods dipping into a four-year low, while services activity growth decelerated for a fifth straight month amid weaker domestic demand. In light of those developments, we project output growth in the region to have contracted by another 0.1% quarter-on-quarter, the second in a row thus pushing the country into a technical recession in Q3. In annual terms, we now anticipate the German economy to have shrunk by 0.1% from a year ago in 2024, while in 2025, growth should come in weaker, at 0.7%, from 0.8% a month ago.     

Consumer prices drop below 2%. On a positive note, Euro Area inflation fell below the ECB’s 2% objective in September, at 1.8% year-on-year, with the fall being entirely driven by strong declines in energy prices. Core inflation on the other hand, a more reliable gauge of underlying price pressures, fell only marginally, from 2.8% a month ago to 2.7% in September. Services inflation cooled slightly to 4.1%, while goods price growth stabilized at 0.4% year over year. At the country level, inflation dropped below 2% in all four leading European economies. Looking ahead, inflation should average 2.4% in 2024 and fall further in 2025 averaging 2.2%. However, core inflation will remain somewhat stickier, particularly in the short term, as salary growth will remain above their pre-pandemic levels and expected falls in wage growth will remain more volatile. As a result, core inflation is projected to average 2.9% in 2024, from 4.9% in 2023, and decline to 2.5% in 2025.

A weakening growth outlook and falls in inflation pave the way for an October cut. After two rate cuts in June and September, the European Central Bank (ECB) is almost certainly going to lower again its three main policy rates in its October meeting by another 25 basis points (bp). Strong beliefs that inflation is on track to return back to 2%, and timelier soft data pointing to a weaker growth outlook for the EA are likely to prompt the ECB to adopt a more dovish stance moving forward. We expect it will lower its interest rate one more time in 2024 thus, bringing the deposit rate at 3.0%. As for 2025, assuming inflationary risks remain anchored, and Europe’s outlook remains weak, the ECB could accelerate further the pace of rate cuts, lowering its key policy rates more than four times.

A resilient labor market will keep supporting economic activity in the region. Despite the slowdown in growth momentum, the Euro Area’s labor market continues to show remarkable resilience. Unemployment rate has stabilized at the all-time low of 6.4%, while the bloc employed another 789 thousand workers in H1 2024. Looking ahead, the EA job market will retain its strong position even as signs of labor demand cooling have intensified more recently with open positions falling at a fast pace and hiring intentions having turned more sour. As a result, employment in both 2024 and 2025 is going to come in significantly weaker than in 2023, growing at an annual rate of 0.7%. Nonetheless, the slowdown in labor demand is unlikely to translate into any major spikes in unemployment claims, with the jobless rate expected to tread below 7% over the forecasting horizon.