Expectations for Interest Rate Cuts Rise Due to Germany

Despite a slight recovery, the main indices of business sentiment (PMI indices of purchasing managers) for the euro area in November still indicate a recessionary trend. The most reliable business barometer for the euro area – the PMI index for the services sector rose by 0.4 points to 48.2 points, marking the sixth consecutive announcement below the 50-point threshold, which historically indicates a recession.

At the same time, the PMI index for the manufacturing sector increased to 43.8 points, confirming an even stronger recession in the production part of the economy. Speculation has intensified regarding the ECB’s intervention to ‘cut’ interest rates in the apparent absence of fiscal stimulus after the Federal Constitutional Court in Germany ruled that the decision to allocate as much as 60 billion euros for climate policies was illegal.

Namely, the cumulative increase in interest rates of 450 basis points, combined with a weakening fiscal stimulus over time, is dampening domestic demand, which cannot be offset even by a (potentially) significant recovery in exports.

Therefore, following a slight real GDP decline in the euro area in the third quarter of -0.1 percent quarter-on-quarter, we expect a somewhat larger reduction in economic activity in the last quarter of 2023, according to HUP’s analysis Focus of the Week.

– The current recession could last through the first half of next year, after which no significant recovery should be expected as long as the ECB does not significantly lower interest rates. Thus, after weaker GDP growth this year, we expect de facto stagnation in the euro area economy in 2024 (growth of barely 0.1 percent), while the German economy could decline by 0.3 percent, writes HUP’s chief economist Hrvoje Stojić.

The deteriorating business climate is likely to prompt a downward correction of the ECB’s macroeconomic projections in December, which definitely eliminates the need for further interest rate hikes as the main weapon in the fight against inflation, and strengthens speculation regarding interest rate cuts during the next year.

So far, the recession has not affected employment due to strong demand for labor and rising wages, which, combined with strong corporate balance sheets, suggests a ‘shallow’ recession despite the significant rise in interest rates. The easing of disruptions in foreign trade and new generation EU funds also have a stabilizing effect.