Eurozone - ECB probably has done enough
GDP essentially stagnated through 2022Q4-2023Q2, and weakness is expected to continue. Headline inflation came in above our expectations in recent months, largely because energy and food price inflation turned out higher. We have raised our forecasts for headline inflation. The ECB raised policy rates in September, whereas we had expected no change. We continue to expect rate cuts to start in March 2024.
Eurozone 2023Q2 GDP was revised lower to 0.1% qoq, down from the first estimate of 0.3% qoq. This means that GDP was roughly stagnant during 2022Q4-2023Q2. During these three quarters, private consumption contracted (-0.7% in total), government consumption was broadly unchanged and fixed investment grew moderately (0.4%). A large positive contribution from net exports (0.8 pps, mainly thanks to a drop in imports), prevented GDP from contracting during this period. Looking ahead, we expect the weakness in the eurozone economy to continue for the time being, with GDP probably contracting moderately or remaining close to stagnant during H2 2023-H1 2024. Data and surveys published in recent weeks have supported this view. The September PMIs remained in contraction territory (i.e. below 50). Although the Services PMI increased somewhat and came in higher than expected (at 48.4), its forward looking expectations component dropped lower, signalling declines in the headline PMI in the coming months.
Meanwhile, we have seen early signs of the labour market turning. Employment growth in persons has slowed down from 0.5% qoq in Q1 to 0.2% in Q2 and employment growth in hours worked from 0.9% to 0.2%. Surveys, such as the PMI and the EC’s Economic Sentiment reports have signalled a decline in employment in industry and a slowdown in job growth in services. Based on the changes in economic activity in recent quarters, we expect employment growth to also stagnate or turn slightly negative in the next few quarters, implying that the unemployment rate will start moving higher.
As described in this month’s Global View, we have revised our forecasts for headline inflation higher, mainly due to higher energy and food inflation. Nevertheless, we expect disinflation to continue for the rest of this year. Base effects will continue to reduce food inflation. Meanwhile, core inflation should also ease, as demand for goods and services is expected to weaken and wage growth is expected to slow, which will also reduce inflation in labour intensive services.
The ECB raised the deposit rate by 25bp in September (to 4.0%), which was against our expectation for no change. Although the central bank will remain data dependent going forward, it did hint that based on the existing outlook, it may have done enough and that the rate hike cycle may be over now. The ECB lowered its forecasts for GDP growth in 2023 and 2024 significantly, but still seems too optimistic on growth. We continue to expect macro outcomes (both growth and inflation) to come in below ECB expectations. Our base line is that the peak in the deposit rate has now been reached. We still expect a rate cut cycle to begin in March 2024. We now see the deposit rate at 2.25% by the end of 2024 (was 2.0%).