Eurozone inflation, growth and ECB speak

Thanksgiving week is usually a lighter one when it comes to data releases in the US. Apart from a PCE and core PCE inflation numbers that came in line with expectations at 2.3% and 2.8% respectively, there has not been much data to move the dial. In Europe, on the other hand, there have been a few data releases and central banker interviews that are worth commenting on.

Starting with inflation, markets have received positive news as releases across the continent have been lower than forecasts, with the highlights being Germany at 2.4% and France at 1.7%. These EU harmonised prints were 0.2% and 0.1% lower than expected, respectively. Eurozone aggregated numbers came at 2.3% and 2.7% for headline and core respectively. It is important to note that on a month-on-month basis, all three of them were slightly negative in the headline measure. The ECB’s inflation expectations survey showed 2.1% for three years ahead, which is the lowest since Q1 2022. Even accounting for the fact that core inflation is slightly higher than headline and that services inflation is not yet where the ECB would want it to be, these numbers are further evidence that the battle against inflation in the Eurozone is in its final stages. The visibility for the ECB to continue cutting rates is good, and the path seems the clearest of large central banks which means the euro curve should remain the best anchored of the peer group.

Regarding growth, the October PMIs last week left a bitter taste in investors’ mouths as both the manufacturing and services surveys came in markedly below consensus. This was something of a surprise for us given Q3 growth in the Eurozone was robust. There have been somewhat divergent views from different ECB officials when it comes to the growth picture going forward and the impact on monetary policy. Executive board member Isabel Schnabel said in an interview this week she was not in our camp regarding the “surprise” element of the PMIs, something she attributed to political uncertainty due to the US elections and the unstable situation in some larger Eurozone countries. She was in our camp though when it comes to cyclical growth prospects; her comment was that “on the cyclical side, we continue to expect a consumption-driven recovery helped by rising real incomes and falling interest rates”.

Schnabel was also very clear that she does not see the risk of a recession at this stage, pointing out that the PMI surveys haven’t been the most reliable indicators recently. “They have been a bit weaker than the hard data, so before drawing any strong conclusions about the services sector, I would wait for the hard data,” she said. Finally on tariffs, as one would have expected, Schnabel thinks more clarity is needed to properly assess the impact. But she did say tariffs would pose “some downside risks to economic growth in the euro area”. In the rest of the interview, while she acknowledged the Eurozone has some structural challenges and that growth is not particularly strong, at the same time she did not sound overly worried about short-term growth.

Francois Villeroy, the French central bank head, sounded a lot more dovish. He was unusually outspoken about the ECB meeting on December 12, saying that “Seen from today, there is every reason to cut” at the meeting and that “optionality should remain open on the size of the cut, depending on incoming data, economic projections and our risk assessment”. He also discussed how the ECB should not let inflation fall below target in future, and that he would not discard future use of negative rates under exceptional circumstances.

We tend to side more with Isabel Schnabel’s comments regarding growth. Quarter-on-quarter growth in the Eurozone has accelerated from zero in Q3 2023 to 0.1%, 0.3%, 0.2% and 0.4% in the four quarters that have followed. While these numbers are far from spectacular, we think they point to the underlying resilience of the Eurozone economy at the moment. We think the ECB will continue cutting rates slowly, with a 25bp cut in December most likely as we do not think the economy needs a 50bp cut at this stage. As rates move lower in coming quarters, there is a possibility that savings ratios begin to decline from their post-Covid peaks to more normalised levels, thereby supporting consumption and growth.

While we are not predicting a growth boom in the Eurozone and we remain attentive to potential tail risks due to the recent escalation in Russia’s war on Ukraine, it is fair to say that at the moment we are not overly worried about the Eurozone’s growth trajectory.