Strong Q3 numbers should not mask the Euro Area’s underlying weaknesses.
Euro Area grew in Q3 at its fastest pace in two years. The Euro Area economy beat all expectations in Q3, expanding by a robust 0.4% quarter-on-quarter (q/q), the highest rate in two years. Among leading economies, Germany surprised to the upside, expanding by 0.2% q/q eventually dodging a much-anticipated technical recession in Q3. The French economy also outperformed expectations, growing by a solid 0.4% q/q, amid strong private and government spending spurred by the Olympics, while Spain retained for a third consecutive quarter its strong growth momentum, expanding by 0.8% from a quarter ago. Italy, on the other hand, undershot consensus forecasts, with Europe’s third largest economy stalling in Q3. Among other member states, the Irish economy also stood out in Q3, with the region growing by an impressive 2.0% from a quarter ago on the back of strong multinational activity, adding a 0.1% to the EA’s growth aggregate.
Despite strong readings in Q3, growth is unlikely to continue at this pace. Better-than-expected growth rates in Q3 should not mask EA’s underlying economic weaknesses. First, private sector activity in October remained sluggish, with data from the Purchasing Managers’ Index (PMI) showing manufacturing woes persist and services activity growing only modestly. Second, on private spending, though consumer confidence continued to improve in October, it has to yet translate into stronger retail spending, while higher savings rate points to more wary consumer behavior. Third, data on gross fixed capital formation showed that private investments continued their freefall in the region. And finally, the export outlook continues to be fragile, with latest data showing volume of exports order books dipping further into negative territory in October and stockpiling increasing. All things considered, EA’s economic outlook will remain weak in the near-term, as solid growth in Q3 was primarily a result of one-off contributors rather than factors that pave the way for more solid growth over the medium-term. We still project the region to grow below trend in the near-term, with growth averaging 0.9% and 1.2% in 2024 and 2025, respectively.
Inflation rises in October but remains below the 2% threshold. Annual inflation in the Euro Area increased to 2% in October, from 1.7% in September. Energy prices falling less steeply compared to a year ago and higher annual food inflation were the main reasons behind the slight upturn in consumer prices. Core inflation, however, which excludes volatile food and energy price pressures, remained unchanged from a month ago at 2.7%. Similarly, annual services inflation, another key indicator monitored carefully by the ECB and closely linked to domestic wage growth pressures, held steady from a month ago at 3.9% year-over-year. By country, domestic prices increased in all four leading economies, although they remained below the ECB’s 2% objective. Looking ahead, we make no changes to our projections, still expecting headline inflation to average around 2.4% in 2024 before falling further into 2025 at around 2.1%. Core inflation though will remain stickier in the short-term given the labor market remains extremely tight and wage pressures continue. Thus, we project core annual inflation to average just below 3% in 2024, before getting closer to 2.5% in 2025. With the threat of tariffs now looming, given the US election outcomes, the threat of both inflationary pressures and low growth are now very real. We will be looking carefully at the new US administration policies to reflect on the risks ahead.
Expect another rate cut in 2025. Following three cuts in June, September and October, the European Central Bank is expected to end 2024 with one last rate cut in its December meeting. And while a worsening growth outlook had recently raised prospects of a chunky 50bp cut, a still very tight labor market that also keeps wage pressures elevated make a 25bp cut in December a more likely scenario. Looking further ahead, Europe’s brittle near-term economic outlook fueled by waning business and consumer confidence are likely to push the bank to accelerate the pace of rate cuts in 2025. As a result, we still see the ECB lowering its key rates at least five more times in 2025, bringing the deposit rate at around 1.5% by the end of next year. More importantly, as Trump’s second term has shifted risks to Europe’s growth outlook to the downside, the probability of the deposit rate going below 1.5% must not be overlooked.
Unemployment unchanged at record-lows as companies continue to hoard labor. The Euro Area’s labor market remained robust in September. Unemployment stood at the historical low of 6.3% as companies continue to hoard labor likely in anticipation of skills and talent shortages intensifying in the future. However, squeezed profit margins amid weaker economic activity and stagnant productivity growth are putting added pressure on European employers, eventually threatening the bloc’s labor market resilience too. As a result, while we do not see unemployment to experience large increases in the near-term, a small uptick in the bloc’s jobless rate should be expected given the economic conditions are unlikely to turn brighter any time soon.
For more resources on the European economy, please see our monthly Economy Watch report and annual long-term outlook (October 2022).
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