ECB about to finally ease restrictions? – Economy fails to pick up speed

Shortly before the ECB's interest rate decision this week, when the monetary authorities are likely to cut interest rates, the economic problems in the eurozone are increasing. According to a report by Bloomberg, consumers are putting spending on hold, jeopardizing the European Central Bank's economic hopes. If there is no gradual improvement, the ECB will probably have to stimulate the economy with further interest rate cuts sooner than expected.

Eurozone consumers are in no rush to open their wallets – leading some to question whether the economic recovery they were supposed to be leading will ever happen. Growth in the 20-nation bloc, which had been recovering in the first half of the year, is stalling. Manufacturing remains in crisis, households are failing to pick up steam and consumer sentiment is below pre-pandemic levels.

ECB about to finally ease restrictions?

With inflation now approaching 2%, some European Central Bank officials see the weakening economy as another reason to push ahead with rate cuts this week. If the weakness continues into 2025 and pushes inflation below target, investors and analysts may see a more minimal monetary easing needed.

“Sluggish growth seems to be a greater concern for the ECB recently,” said Simon Wells, chief European economist at HSBC. “Weak consumption could also push central bankers in a more dovish direction.”

On paper, the conditions are in place for an upturn in consumption and thus in the economy: inflation has fallen from a high of 10.6% to 2.2%, unemployment is at a record low, incomes are rising faster than prices and falling borrowing costs are making mortgages cheaper again.

“The most important thing is that inflation has really fallen significantly and interest rates are starting to fall,” Latvian central bank governor Martins Kazaks said last week. “This is very good for the public because purchasing power is starting to grow.”

Despite these factors – as well as the double stimulus from hosting the European Football Championship in Germany and the Summer Olympics in France – spending is subdued. Private household consumption fell by 0.1% in the second quarter, Eurostat announced on Friday.

Eurozone: Consumption is the weak point

In Germany, the largest of the euro area's 20 economies, it fell even more sharply over the same period, and household confidence has since fallen amid mounting layoffs and corporate bankruptcies. Car giant Volkswagen suffered another blow last week when it announced it may close plants in its home market for the first time in its 87-year history.

“We expected that consumption would contribute to growth in Germany, but that has not happened so far,” said Olaf Roik, chief economist of the German Retail Association. “Our hopes now lie in the second half of the year.”

Southern Europe is doing better, but is also facing headwinds – especially as countries like Italy and Spain cut back on living expenses.

“Households can expect fiscal policy to be less favourable next year as every economy will have to make efforts to reduce its debt,” said Laurine Pividal, economist at Coface. As government support programmes expire, this could “impact households' expectations regarding the government's fiscal policy”.

For the region as a whole, consumption appears to be a weak point, calling into question the ECB's forecast of a 0.9% rise in gross domestic product this year. Indeed, retail sales fell short of estimates at the start of the third quarter, rising by just 0.1%, data released last week showed.

“Nominal spending expectations are at their lowest level since February 2022, when Russia invaded Ukraine,” the ECB said in its latest monthly consumer survey.

ECB: Further interest rate cuts are likely

Central bankers at the Frankfurt-based institution discussed the issue at their last meeting in July. A sharp rise in savings at the start of 2024 “raised questions about the consumption-based representation in the projections,” a report on the meeting said, although the conclusion was that the outlook for rates remained flat.

However, analysts surveyed by Bloomberg expect forecasts for the economy's growth this year to be cut at this week's meeting, increasing the likelihood of a rate cut in October on top of moves in September and December that investors have already priced in.

“Such a move could well be considered if economic performance disappoints, which is a clear risk in the near term,” Bank of America analysts said. Fifty basis points of easing – the equivalent of two standard-size rate cuts – for the rest of the year is a “lower bound given the lack of a clear pickup in economic activity,” they said.

Economy: Waiting for the recovery

Given that real household income is below end-2019 levels, depressed consumption is not surprising, according to Fitch Ratings, which still sees the conditions for a recovery “that will boost growth in the euro area.”

And there are certainly some who believe that such an upturn will come – just a little later than hoped.

Higher incomes should “increasingly be reflected in rising household spending,” the Bundesbank said in August.

Dorian Roucher, an economist at France's statistics office Insee, said consumers appear to be only “gradually” taking into account cooler inflation after changing their behavior much more quickly in response to the price increase.

FMW/Bloomberg

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