European Market Review
European bond yields fell, with the US-German spread exceeding 215 bps. French bonds outperformed Spanish due to economic challenges. The Euro weakened, and oil prices rose 5.18%.
European bond yields declined over the week, with the yield spread between 10-year US Treasuries and German Bunds widening further, surpassing 215 bp. French 10-year bond yields have again surpassed those of Spanish Bunds, primarily due to ongoing economic difficulties in France and a rising debt-to-GDP ratio. Equity markets showed mixed results, with Italy experiencing the sharpest decline, dropping more than 2%. The Euro weakened to 1.0417 against the US dollar, and further weakness is expected as the European Central Bank is likely to implement additional rate cuts following the Federal Reserve's actions. In commodities, Brent crude oil prices increased by 5.18%, driven by Russia's warning regarding the potential use of nuclear weapons in its ongoing conflict with Ukraine. However, the rising supply from non-OPEC countries coupled with sluggish demand, particularly from China, suggests that oil prices will face downward pressure, mitigating the risk of significant price hikes.Europe View Synopsis
The Eurozone
PMI signals ongoing stagnation and economic weakness, with Germany facing a deeper contraction. The ECB is expected to implement another rate cut. UK inflation has risen. Overall, uncertainty persists across major European economies, with growth prospects remaining subdued.
The Eurozone's economic weakness is underscored by a decline in the composite PMI, which fell to 48.1 in November, signalling stagnation ahead. While GDP and inflation have outperformed expectations, the latest PMI raises questions for the ECB, which faces a delicate decision in December. Growth prospects remain subdued, particularly with contractions in both the services and manufacturing sectors. Germany, the region's largest economy, narrowly avoided recession but is grappling with stagnation, political instability, and shifting global dynamics, complicating growth prospects. Amid these challenges, the ECB is expected to cut rates again in December, with more frequent cuts than the Fed, which may pause in January. The UK's inflation data for October rose unexpectedly, signalling that the Bank of England may adopt a more cautious approach to rate cuts. As a result, the central bank could pause its rate reduction plans in December, with the possibility of resuming cuts in 2025, depending on future inflation trends. Overall, economic uncertainty persists across major European economies.
Business Activity
The Eurozone PMI signals ongoing economic weakness, with stagnation expected. Germany faces deeper contraction amid political instability, weak demand, and deteriorating service sector performance.
The Eurozone's composite PMI fell from 50 to 48.1 in November, further intensifying concerns about the region's economic prospects. Although recent data, including GDP and inflation, have outpaced expectations, the PMI’s decline raises questions for the ECB ahead of its December meeting. Policymakers now face the challenge of discerning whether this signal is a transient anomaly or a genuine indicator of deeper economic weakness that warrants a shift in monetary policy.
November’s PMI underscores the fragility of the Eurozone's economic recovery. At the October ECB meeting, President Christine Lagarde highlighted the downward trend in key economic indicators, particularly the PMIs, which had fallen below 50 in September, signalling contraction. While some data, such as GDP, has shown improvement since then, the latest PMI indicates that the region is still grappling with fundamental weaknesses. With stagnation expected in the fourth quarter, growth prospects remain weak, especially as both the services and manufacturing sectors continue to contract, with services dropping from 51.6 to 49.2 and manufacturing from 46 to 45.2. Input cost inflation, driven by wage growth, and subdued price pressures suggests that inflation concerns may ease in the short term. However, the broader outlook remains uncertain, with weak external demand adding to the region’s economic challenges.
Germany, the Eurozone’s largest economy, is facing a particularly steep downturn. The country’s composite PMI dropped to a nine-month low of 47.3 in November, down from 48.6 in October, signalling a deepening contraction. This decline was driven largely by an unexpected fall in the services PMI, which slipped below 50 for the first time since February. While the manufacturing sector showed a slight improvement, with its PMI rising to 43.2 from 43, the broader picture remains bleak. The German economy is now dealing with the dual pressures of weakening domestic activity and the broader European economic slowdown. This, coupled with political instability following the recent government collapse, is likely to weigh heavily on Germany's growth prospects in the coming months.
We anticipate that the ECB will implement another rate cut in December. Rate reductions in Europe are likely to occur more frequently than in the U.S., where the Fed may halt cuts as early as January. This divergence in monetary policy is expected to put downward pressure on the euro, leading to further depreciation.
German GDP
The German economy narrowly avoided recession, with stagnation persisting. Key challenges include structural weaknesses, shifting global dynamics, and political uncertainty, leaving growth prospects uncertain.
The German economy narrowly avoided a technical recession in the third quarter, growing by a modest 0.1% QoQ, down from an initial estimate of 0.2%. This follows a contraction of 0.3% in the second quarter, marking a prolonged period of stagnation. Despite this slight growth, the economy remains largely stagnant, with GDP levels barely higher than those recorded more than four years ago, before the pandemic. Key drivers of the third-quarter expansion included private consumption, which rebounded to 0.3% QoQ after contracting by 0.5% in Q2, and inventory buildup. However, net exports and investments weighed on overall performance, and the substantial inventory buildup over the past two quarters raises concerns. If businesses begin to reduce their stockpiles, it could further dampen economic activity in the near term.
Looking ahead, the German economy faces a range of persistent challenges. While the pandemic and the war in Ukraine have exacerbated pre-existing structural weaknesses, the deeper issue lies in the shifting global economic landscape. Germany’s traditional growth model—relying on cheap energy and robust export markets—is increasingly untenable, especially as China has become a dominant player in manufacturing. Amid uncertainty surrounding future trade policies and the political instability caused by the collapse of the German government, the growth outlook remains fragile. Although a new government could provide the much-needed policy clarity, the implementation of reforms, such as tax cuts, deregulation, and investments in infrastructure, digitalisation, and education, will be challenging. With the potential for a trade war with the U.S. further complicating the situation, a winter recession appears increasingly likely. Germany’s future growth will depend largely on the new government’s ability to navigate both domestic policy obstacles and intensifying global competition.
Germany has failed to evolve, remaining entrenched in a traditional economic model. We believe it will take considerable time to return to pre-pandemic growth levels of approximately 0.5% to 0.6% annually.
UK Inflation
UK October inflation rose to 2.3%, driven by energy and services. Core inflation exceeded expectations, reinforcing the Bank of England’s gradual rate cuts.
UK annual CPI inflation for October rose to 2.3%, up from 1.7% in September and slightly surpassing the consensus forecast of 2.2%. The increase was driven by higher energy prices and airfares, with services inflation reaching 5%, above expectations. Core inflation also exceeded forecasts, registering 3.3%, up from 3.2% in September, compared to the anticipated 3.1%. This data is likely to support the Bank of England's gradual approach to rate cuts, aligning with the projected pace of monetary easing across major central banks: The Fed (lowest), the BoE (middle), and the ECB (most aggressive). Services inflation is expected to remain around 5% through the winter, while headline CPI may approach 3% in January, reducing the likelihood of a rate cut in December. However, the BoE may accelerate its easing cycle in the spring, as core services inflation, which excludes volatile categories like rents, airfares, and package holidays, shows signs of easing. Despite these variations, the Bank is likely to continue its gradual rate cuts, potentially starting with a pause in December, followed by more aggressive action in early 2025, with rate cuts in February and March.
Given this data, we anticipate a pause at next month's meeting, followed by the resumption of rate cuts in February 2025.
Disclaimer
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Credit: Dolfin Europe