Weakening economic momentum may be one of the reasons the European Central Bank holds off on raising interest rates for now.
While much of the eurozone's attention is currently focused on France's fiscal troubles and bond market issues, the latest surveys suggest that data due this Friday will show eurozone third-quarter economic growth slowing to 0.2% from 0.6% in the second quarter.
At the same time, several other surveys indicate that inflation across the eurozone's four largest economies did not show a clear broad-based upward trend in October.
Eurozone Q3 Growth Expected to Slow
The European economy, which had shown strong resilience since the Middle East conflict broke out at the end of February, may be starting to lose momentum, with business activity also showing signs of fatigue.
Although overall performance remains solid, Simona Delle Chiaie, chief eurozone economist at Bloomberg Economics, believes there is still reason for caution. "The bigger question is what happens next," she said. "With inflation persistently high and financial conditions tightening sharply, downside risks to growth are accumulating."
During the third quarter, European economic output was hit by multiple factors, including summer heatwaves, low water levels on major waterways, and surging global bond yields. Since then, the overall environment has deteriorated further, with France facing large-scale protests and growing questions about its public finances. As France's private sector contracted in October, Carrefour SA warned that nationwide looting incidents would deal a heavy blow to the company's performance. The supermarket operator's shares recorded their worst week since the global financial crisis.
As the eurozone's largest economy, Germany has seen some improvement after years of difficulties, supported by large-scale government spending. Even so, the Bundesbank still expects Germany's economy may stagnate in the third quarter.
On the inflation front, the eurozone inflation rate appears destined to rise to 4% by the end of the year, but performance this month has been mixed across countries. This is partly due to Germany's fuel tax relief policy, though analysts also expect Spain's inflation data to ease.
Eurozone Inflation Performance to Diverge
Eurostat data shows the eurozone inflation rate rose to 3.8% in September, up from 3.2% in August; energy prices soared 18.8% year-on-year, becoming a key driver of rising inflation. In response to energy price increases, several European governments have taken measures including cutting fuel taxes, intervening in energy prices, and providing subsidies to households and businesses. However, subsidies can only ease short-term burdens and cannot eliminate the root causes of rising energy prices. The surge in energy prices triggered by the Middle East conflict is putting pressure on eurozone inflation.
Nevertheless, policymakers stress that they have yet to see second-round effects such as wage increases. Some officials, including ECB Chief Economist Philip Lane, have said a "measured" policy response should be sufficient to restore price stability. ECB President Christine Lagarde previously said that high eurozone inflation driven by elevated energy prices has not yet passed through to the broader economy. She said ECB officials are assessing "how much indirect impact is being transmitted through the economy and how we can best judge ahead of time if second-round effects begin to emerge."
Bank of France Governor Emmanuel Moulin has taken a similar stance on inflation to Lagarde. He said the ECB expects "indirect effects and second-round effects to remain contained," with eurozone core price indicators accelerating only "modestly."
Slowing economic growth and inflation pressures that have not worsened further may have reduced the urgency for the ECB to act. For economists, this means the ECB may wait until December to raise the deposit facility rate for the third and final time, rather than hiking this week. At this week's meeting, the ECB is expected to keep the deposit facility rate unchanged at 2.5%.
Institutional Views Diverge
Some institutions remain optimistic about economic growth. BNP Paribas believes that excluding volatile Irish economic data, the European economy still maintained a resilient performance in the third quarter, partly helped by lower unemployment. However, Jens Eisenschmidt, chief European economist at Morgan Stanley, believes risks are gradually accumulating. He listed energy shortages as one of the risks that may lie ahead. "In the short term, there appears to be no quick fix to the energy crisis," he said. "Given Germany's low gas storage levels, if winter temperatures are cold, we may even have to consider the risk of energy rationing."
The bond market is also a factor to consider. In France alone, the extra yield premium investors demand to hold French 10-year government bonds rather than German bonds of the same maturity has risen to levels not seen since the European debt crisis. ECB President Christine Lagarde said this month that bond yields have risen "significantly" since the September meeting. This change will drag on economic growth and reduce the extent to which high energy costs are transmitted to the broader economy.
While denying various claims of a debt crisis, Bank of Italy Governor Fabio Panetta acknowledged last Thursday that the current situation would act as a "drag" on economic growth. Bank of America believes that given all these factors, ECB policymakers will want to send a more dovish policy signal at the upcoming meeting than at the September meeting. Bank of America economists led by Ruben Segura-Cayuela said: "Financial conditions remain tight and are likely to tighten further; spreads continue to widen, and France's political situation is exacerbating these pressures." They noted that the ECB "needs to pay more attention than recently to the impact of current developments on economic growth."
Comments