Eurozone data soothes ECB growth concerns

In what has been a busy week for macro news in Europe, the latest round of data for the Eurozone delivered a surprise that could have implications for the European Central Bank’s (ECB) interest rate plans.

Starting with growth, the ECB had made clear its concerns about economic activity post-summer as Purchasing Managers’ Index (PMI) readings fell below 50 (indicating contraction), potentially pointing both to a lower rate of growth than that seen in the first half but also lower than ECB staff projections in September.

However, Wednesday’s figures showed real GDP growth in Q3 of 0.4% quarter-on-quarter (QoQ), double both the consensus estimate and ECB forecast of 0.2%. By country, Germany saw a downwards revision to Q2 GDP growth (to -0.3%) but showed a stronger than expected 0.2% in Q3 (many were expecting a second consecutive quarter of contraction). Spain again outperformed with a solid 0.8% QoQ growth rate for Q3, while France was boosted by the Olympics and posted 0.4%. Italian GDP growth remained flat at 0.0% QoQ.  

Part of the confidence of the ECB’s growth forecast – stronger growth this year than last year – came from excess savings, which European consumers held onto after the pandemic as a result of the gas crisis stemming from Russia’s invasion of Ukraine. With an unemployment rate that remains at record lows in the Eurozone (it actually fell again in August), declining deposit rates and stronger consumer sentiment should drive stronger consumption, and indeed we started to see broader signs of this in the Q3 numbers with stronger domestic consumption across most countries.

It’s worth saying that part of the Eurozone’s strong Q3 growth print came from a strong (through volatile) Irish growth rate of +2.0% in the quarter; excluding this, the growth rate was 0.3%. But this is still stronger than consensus and allays some of the fears that the ECB’s governing council might have had about economic activity, even if this isn’t strictly part of its mandate.

October’s headline inflation figure rebounded from 1.7% year-on-year (YoY) in September to 2.0% YoY, stronger than consensus forecasts of 1.9%, while core inflation of 2.7% also beat expectations by 10bp, though it remained flat versus the prior month. As expected, the energy base effects of previous months partly reversed, with the -6.1% YoY growth rate in September improving to -4.6% in October, while the Food, Alcohol and Tobacco component accelerated to 2.9% YoY, 50bp higher than the print in September. Services inflation was stable relative to the prior month at 3.9%.

What does this mean for the ECB?

First, a 50bp cut, as mentioned by ECB governing council member Mário Centeno earlier this week, is at this point unnecessary in our view. We have argued recently that the pace of cuts from the ECB should move to meeting by meeting (rather than every other meeting), but the data does not suggest a more accelerated path of cuts than that, at least at the moment.

Second, the ECB’s year-end 2024 forecast for headline inflation (made in September) is 2.5%, while its year-end forecast for core inflation is 2.9%. As ECB governor Christine Lagarde said on Thursday, the war on inflation is not yet won, but even with the tick higher in October it remains short of those year-end forecasts. We expect headline YoY inflation to increase into December, but it will most likely end up below the ECB’s September forecast for 2024. As we have said for a while, the real driver of lower core inflation will be 2025’s wage demands, with the core print likely to move into the low 2% area in the first half of next year.

Finally, the fears around growth will be somewhat ameliorated by the Q3 print, and the ECB will gain some confidence in particular from the pick-up in domestic consumption. Ultimately, we think this is a good thing for European credit and should continue to support spreads over the coming quarters.