Eurozone - Economic weakness to continue for a while
GDP was stronger than expected in 2023Q2, but the underlying picture remains one of ongoing economic sluggishness. Core inflation has not yet convincingly declined, though it is only specific parts of services inflation that are still rising; the rest of the HICP components have already peaked and are slowing. The ECB has probably ended its rate hike cycle. We expect rate cuts to start in March 2024
Eurozone 2023Q2 GDP came in higher than expected at 0.3% qoq. Meanwhile, the Q1 result was revised higher, to 0.0%, up from -0.1%. This means that the eurozone was not in technical recession after all last winter, and GDP only contracted in one quarter (-0.1% qoq in 2024Q4). Despite the somewhat better than expected outcome for GDP in 2023H1, we still expect a considerable period of economic sluggishness, with GDP probably contracting moderately or being close to stagnant during H2 2023 and H1 2024 (see also the first chapter of our Global Monthly). Activity and survey data published since the start of the summer suggests further weakness to come. For instance, the manufacturing and the services PMIs each have persistently fallen over May-July, while business confidence also declined during these three months. We think that the unprecedented sharp interest rate hikes by the ECB since the middle of last year will continue to feed through to the economy in the coming quarters. Moreover, there are early signs that labour market conditions are turning and that the labour market has become less tight (eg. the vacancy rate has declined). Indeed, the ECB report of its main findings from contacts with non-financial companies mentions that ‘many contacts continued to find recruitment challenging given shortages of various skills, but there were also a few signs of increasing slack in some parts of the labour market.’
Headline inflation has continued to fall in recent months, but the core rate has stagnated, with declining goods price inflation offset by rising services inflation. Within services. an upward base effect in transport services was a major factor pushing total services inflation higher, while other parts of services inflation (e.g. communication services, personal care) have declined in recent months. Looking ahead, we expect disinflation to continue during the rest of this year. Core inflation will probably decline more slowly than headline inflation, but core inflation should also ease, as demand for goods and services will weaken and wage growth is expected to slow, which will also reduce the inflation rate of labour intensive services.
The ECB raised the deposit rate by 25bp in July, as was widely expected, while also signalling that a pause in the rate hike cycle was likely. Our base line has remained that the peak in the deposit rate (3.75%) has now been reached and that there will be no further hikes. We have shifted our expectation of a pivot in the policy stance a few months forward and now expect a rate cut cycle to begin in March 2024, instead of our earlier forecast of December of this year (see also ). This largely reflects the resilience in services inflation and the labour market up until now. We expect a series of rate cuts will kick off in March 2024, and we continue to see the deposit rate at 2% by the end of next year.