Eurozone - ECB in wait-and-see mode until late summer

In June the details of Q1 growth (+0.3%) were published. Growth was driven by private consumption and net trade. Destocking, due to weakness in manufacturing, lead to a negative contribution from inventories and high interest rates lead to a contraction in investment. Overall, the economy is slowly regaining its footing with growth momentum remaining positive approaching the second half of 2024. Growth is expected to remain positive in Q2 but to edge down compared to the surprising high Q1 figure, as some one-offs – such as strong construction activity and tourism spending which pushed up Q1 growth – fall away. We have penciled in 0.2% of qoq growth in Q2. The picture however remains broadly the same: economic activity is expanding in services, helped by real wage increase and low unemployment, and is bottoming out in manufacturing on the back of increasing trade volumes and a further easing of the energy crisis.

Still, while growth this year will pick up compared to 2023, it is expected to remain below trend for a few reasons. First, past headwinds such as the energy crisis have eased but have not fully resolved yet. Second, monetary policy is still restrictive. A non-negligible share of firms has yet to refinance loans against higher interest rates, which will continue to weigh on activity. Third, for the economy to pick-up steam, a stronger recovery in demand is needed. German factory orders for instance are stabilizing according to April figures, but for manufacturing to expand, factory orders have to pick up considerably. The same holds for consumer demand. Wage growth contributed to consumption growth in the first quarter (+0.2% qoq), but the recovery in real incomes is uneven across countries (see graph), and a significant impulse to demand has yet to materialize. A final reason is geopolitical uncertainty. Recently, trade tensions increased as the Commission proposed to raise tariffs on Chinese EVs, with China possibly retaliating via specific product groups. So far, the developments are in line with expectations and the growth effect is likely to be limited in 2024, but the increase in uncertainty is weighing on the outlook.

Eurozone inflation in May surprised to the upside, driven by services. Indeed, a rise in services inflation was anticipated due to upward base effects from a public transport policy measures in Germany last year, but the increase also reflected the pass through of wages to services prices. This is especially the case in contact-intensive sectors where margins are low and the pass-through is quick. This drove core inflation to 2.9% yoy, up from 2.7% in April. Headline inflation was in line with expectations at 2.6%. Leading indicators, such as the monthly Indeed wage tracker suggest wage growth will continue normalizing over the coming year. As such, while core inflation is likely to stay somewhat elevated in the near term, this lagging aftershock of the energy crisis is unlikely to derail ECB rate cuts. Indeed, at the June meeting the ECB lowered its key policy rates by 25bp. At the press conference Lagarde hinted that a signal on a future move would come only after July. We think the ECB will want to wait for the Q2 negotiated wages data in August before cutting further, and as such, we no longer expect a rate cut in July. Starting at the September meeting, we still expect an extensive rate cut cycle, however, with 25bp cuts at consecutive meetings throughout 2024-25.