There have been more worrying signs about the state of the EU economy over the last week. This comes amidst a change in leadership at the top level, signifying that there is increasing recognition of a problem. But, that doesn’t mean there is a solution coming soon. The issue for the Euro is whether the recent trends will end up impacting monetary policy and drag the shared currency back to parity with the dollar.
EU Commission President Ursula von der Leyen’s sudden change in the composition of the Commission amounts to a reshuffle in the cabinet, if the EU were to be viewed as a single country. Typically, that happens when there is growing discontent over certain policies, which means it’s an event for the market to take note. Although the result hasn’t produced, so far, any change in direction, particularly on the fiscal level. But, it does raise a certain amount of uncertainty for the markets.
The Bad News Doesn’t Quit
Earlier this week, the ZEW current situation survey of economists on Germany came in at -84.5 compared to -80.0 expected. That’s the worst it has been since the middle of the pandemic. The expectations survey was a little better, but still the worst in almost a year. The largest economy in the EuroZone is experiencing a lot of pain, in part thanks to a stronger Euro that hurts exports. The trade dispute with China, and that country’s economic underperformance don’t help, either.
But general slow growth in Germany – and the EU economy as a whole – has been a theme recently, as high prices hurt people’s disposable income, reducing consumer confidence. Europe is still struggling with high energy costs as a result of the war in Ukraine, which pinches corporate profits, and reduces their ability to increase pay, expand production, and overall contribute to growth.
Crisis Time?
What is new is the rate of decline. The Euro Area’s current account dropped by over 20% in July alone. August new car registrations took a significant dive in August, falling -18.3%. That’s a sign that Europeans are likely postponing major discretionary spending. It could also be an effect of the latest ECB moves, as people delay purchases on credit in the hopes of lower interest rates.
That is fine as long as the ECB delivers those lower rates. But, inflation remains above target, despite the lack of consumer demand. Probably because the main factors pushing inflation – energy, housing, food – are not up to monetary policy, but fiscal and regulatory policy. EU regulations on food production and import have dramatically increased costs, and no amount of ECB cutting will fix that.
The Divide Deepens
ECB member from Portugal Mario Centeno was the latest to push for lower interest rates, as part of a growing contingent that fear a recession is imminent. But he is opposed by ECB hawks who worry that deficit spending, particularly in southern European countries, will lead to higher inflation that can be countered by restrictive interest rates.
If the data continues to disappoint, it could signal deeper issues within the EU economy, prompting calls for rate cuts.. For now, the market doesn’t seem to think they are strong enough, and is only pricing in one more easing event this year. But, with other central banks easing quickly, like the Fed, the ECB will come under increased pressure to at least keep the pace. Otherwise, the relatively strong Euro will keep weighing on exports, creating the very real risk that inflation could miss the ECB’s target – by going into deflationary more as a result of a recession.
