Inflation in the eurozone has cooled more than expected, the economy is on the verge of recession, and the European Central Bank has not relaxed its grip on cutting interest rates.
Now that the European Central Bank has reached a crossroads, the key to determining future monetary policy is whether the eurozone economy will land smoothly and only fall into a mild recession, or whether aggressive interest rate hikes will trigger a major recession
On January 5, Deutsche Bank's Chief Economist Mark Wall in the European Economic Outlook 2024 report**,The European economy will fall into a mild recession this yearMonetary policy continues to affect the economy, the labor market is weaker than expected, the economic downturn will continue into the middle of the year, and from the second half of 2024, the European economy will pick up and return to growth.
However, Deutsche Bank bluntly said that the decline in the competitiveness of European companies to a historical freezing point may become the key to whether the European economy can continue to rise in the future.
Deutsche Bank believes that inflation data shows that from the second half of 2023, inflation will fall more than expected, wage growth is peaking, and inflation will continue to fall more than expected in 2024 as corporate profit margins decline, and inflation is expected to fall to 2% in mid-2024, one year earlier than expected by the European Central Bank.
Based on the uncertainty of the economic outlook and the trend of a sharp slowdown in inflationDeutsche Bank expects the ECB to start cutting rates in April and cut rates by 100 basis points quicklyto prevent a rapid rise in real interest rates and avoid a prolonged recessionFor the full year of 2024, interest rates are expected to be cut by 150 basis points, and in 2025, interest rates are expected to be cut by 50 basis points.
Eurozone's gross domestic product (GDP) in the third quarter of this year was flat year-on-year and down 01%, EU GDP remained flat year-on-year, less than expected.
After experiencing the dilemma of stagnant quarter-on-quarter growth from the fourth quarter of last year to the first quarter of this year, the eurozone economy briefly returned to expansion territory in the second quarter, but now the growth trend has reversed, which is also the first negative quarter-on-quarter growth in the eurozone since the third quarter of 2020.
If the eurozone economy continues to decline in the fourth quarter, the eurozone economy will fall into a technical recession. Continued monetary tightening, slowing external demand, lingering energy** impacts, and geopolitical uncertainty have put multiple pressures on the eurozone.
Deutsche Bank believes that the outlook for the European economy is more pessimistic than the market and the ECB's expectationsThe strong transmission of monetary policy will continue into 2024
Deutsche Bank pointed out that as a predominantly bank-based financial system, the financial condition indicators of banks are very important for the eurozone. The best tool for linking banks' financial conditions to the economic cycle is the credit impulse (the volume of new bank loans to GDP as a ratio), and the credit impulse data points to a weakness in the economy starting in the second half of 2023:
More specifically, economic growth has stalled according to credit impulse signals that take into account changes in the savings rate;According to the Standard Credit Pulse signal, the Standard Credit Pulse has started to rise from a very low level.Deutsche Bank noted that the Bank Lending Survey (BLS) is generally ahead of the credit impulsePointing to a turning point in the transmission of monetary policy,The "hawks" of the ECB Governing Council do not want the transmission to peak prematurely, and in their opinion, the policy rate should be eased slowly, but Deutsche Bank believes thatThe drag on corporate net interest income (NII) from rising interest rates will not peak until mid-2024, and there may be clear signs of a peak in the second half of 2024
Even the credit impulse signal, which takes into account changes in the savings rate, is inconsistent with the ECB's expected GDP outcome. In addition, our model suggests that the drag on companies' net interest income from rising interest rates may not peak until mid-year. Overall, there are no clear signs of peak conduction until the second half of '24.Deutsche Bank believes that this is further from the perspective of other conduction dimensions that need to be considered".Increased uncertainty about the economic impact of high interest rates
Since November, financial conditions in the market have begun to ease and return to mid-2023 levels. The Financial Conditions Index is still at historic lows and has begun to tighten again.Deutsche Bank pointed out that the eurozone, as an open economy, has an impact on the external environment for the transmission of monetary policy, which may have a lag:
For example, the relatively high level of corporate debt in the United States or the United Kingdom could affect the economic situation in the eurozone through channels of confidence and confidence.According to Deutsche Bank, there is also a difference between the transmission of monetary policy to the private sector and the public sector
The relatively healthy balance sheet of the private sector will somewhat dampen the magnitude of monetary policy transmission and strengthen the turning point of domestic transmission. However, public balance sheets are relatively more fragile due to the increase in debt during the pandemic.Deutsche Bank noted that the labor market plays a crucial role in the outlook for the Eurozone economy in 2024The employment situation will determine whether the economy has a soft or hard landingPublic debt is rolling upwards amid higher financing costs, which could put pressure on public finances.
On the one hand, if the economy weakens, the number of layoffs will increase, unemployment will rise, the balance sheet of the private sector will weaken, and the transmission of monetary policy will be stronger. On the other hand, whether the labor market is strong or not will affect productivity and unit labor costs, which in turn will affect the upside risk to inflation.Deutsche Bank believes that they are more worriedThe negative impact of the labor market on economic growth, not on high inflation
We view the labor market differently than the ECB, which could explain our expectation of a more dovish outlook for monetary policy.Deutsche Bank believes that the labor market is weaker than expected by the ECB, contributing less to GDP growth and will also lead to a slowdown in inflation in EuropeDespite the larger-than-expected downside inflation in the second months of 2023, in December, the ECB raised its core inflation forecast for 2024. This is because the ECB expects economic growth to slow, but the job market remains relatively robust and companies will not lay off workers on a large scale.
As a result, Ouyang expects productivity growth (i.e., output per worker) to slow, leading to higher unit labor costs, which could lead to more stubborn core inflation. We think,The opposite is more likely to happen
The contribution of employment to real disposable income is smaller than expected six months ago. Post-pandemic job growth, combined with wage growth, means that the increase in labor income has more than offset the impact on real incomes due in part to higher energy costs.Deutsche Bank noted that the deflationary narrative dominated the final months of 2023, but two factors could trigger some inflation concerns in the short term: 1The final composite PMI was revised upwards more than expected in December2.The impact of geopolitical conflicts and the Red Sea crisis on shipping, but Deutsche Bank believes that these two points are notIt won't have much of an impact on inflation in the futureDeutsche Bank believes that one of the most striking data in the European economy in 2023 is corporate competitiveness, which is still considered to be at an all-time low, and in the short term, lower confidence could translate into weaker investment spending and job growth in 2024. In the medium term, it could lead to deindustrialization pressures, higher structural unemployment, and lagging effectsIn our view, this trend is now reversing, with a turning point in purchasing power and the household savings rate appearing to be rising again.
There are several reasons for this:1Businesses are not yet convinced that Europe has sustainable access to cheap energy;2.to the effectiveness of the U.S. IRA green technology subsidy;3.to the competitiveness of China's electric vehicle industry, and the EU's multiple vulnerabilities in terms of technology.Perhaps the biggest risk for businesses in this more tense and rapidly changing geopolitical environment is the sustainability of the European model over the past few decades.
Reaching consensus is always a challenge for the EU, and it will not be easy to impose an agenda of strategic autonomy into a world with strict fiscal rules, which is not just something that Germany can solve. The medium-term inflation outlook will ultimately be blamed on the issue of fiscal stance, which tends to ease over time and become more accommodative in the future, while long-term inflation is more likely to be above pre-pandemic levels and likely to remain above target in the medium term.