Doubts Arise About ECB's Next Steps as Eurozone Business Activity Declines

24 Aug, 2023

Doubts Arise About ECB's Next Steps as Eurozone Business Activity Declines

Eurozone enterprises have been grappling with substantial declines in production and new orders, as indicated by a closely monitored survey. This development raises uncertainties about the European Central Bank's potential move to increase interest rates next month. The flash eurozone composite purchasing managers' index (PMI) from HCOB has hit a 33-month nadir of 47. This drop follows a sudden contraction in services activities and an ongoing decline in manufacturing throughout August. With this decline from the previous month's 48.6, the index has further slipped below the critical 50-point threshold, signifying a shift from expansion to contraction. This scenario has heightened concerns of a slowdown during the latter half of this year, greatly deviating from economists' expectations of a slight dip to 48.5, as per a Reuters poll forecast.

Investors are interpreting the bleak economic prospects as reducing the likelihood of the ECB raising interest rates in the upcoming meeting. The euro has consequently dropped by 0.3% against the dollar, reaching $1.108. Simultaneously, Germany's two-year bond yield, sensitive to rate changes, has fallen by 6.8 basis points to 3%. In terms of consumer sentiment, the EU's consumer confidence index has decreased to minus 16 from the previous month's minus 15.1, putting an end to nearly a year of continuous improvement. Despite economists' anticipation of an improvement to minus 14.3, the index remains below its pre-pandemic average of minus 9.9.

Furthermore, the survey's findings reveal a reversal in the recent decline of inflationary pressures. Companies have registered an increase in the average prices charged for their goods and services, marking the first growth in seven months and pushing the rate above the long-term average. While input costs have continued to drop for manufacturers, there has been a slight increase in costs for service-based companies due to rising wages and fuel prices. Mark Wall, Chief European Economist at Deutsche Bank, emphasizes that the persistent significant drop in PMI data will challenge the ECB's optimistic growth outlook. He anticipates a pause from the ECB in September, cautioning against misinterpreting it as the peak, particularly considering that inflation might not yet align with the ECB's objectives.

Notably, Eurozone negotiated wages have risen by 4.3% in the second quarter, slightly decelerating from the pace seen in the first quarter, according to separate ECB data. This suggests that the previously accelerating wage growth in the Eurozone has stabilized. Coupled with the discouraging PMI data, this situation casts doubt on the feasibility of the projected September rate hike.

The decline in the Eurozone PMI reading, marking its lowest point since November 2020, is predominantly driven by a sharp downturn in the services sector. For the first time since December, service activity has contracted, echoing the persistent, albeit milder, contraction in the manufacturing sector. This synchronicity paints a concerning picture of the Eurozone's economic performance.

The third consecutive monthly decline in new business inflows, the fastest drop since 2012, has led manufacturers to continue job cuts, consequently slowing down hiring in the larger services sector. Germany, in particular, experienced its most significant activity decline in over three years, resulting in a 38-month low for the country's PMI reading. This drop is attributed to falling new orders, diminishing business output, and shrinking inventories in August. France's PMI score remains in contraction territory at 46.6, reflecting a 30-month low in services activity and ongoing significant declines in manufacturing, albeit somewhat less severe than in July.

Economist Andrew Kenningham from Capital Economics interprets the decline in services activity as a signal that the rebound observed in tourism and hospitality is losing momentum. He adds that there are ample reasons to expect the Eurozone economy to slide into a recession during the latter part of the year, with Germany possibly facing the most pronounced challenges. Meanwhile, the UK's economic activity has also dipped more than anticipated in August, with the S&P Global / Cips Flash UK composite output index dropping to 47.9 from July's 50.8. This decline marks the first time the index has fallen below the pivotal 50 levels since January.