Eurozone in recession, recovery expected only in the second half of the year

The main business climate indices (PMI indices of purchasing managers) for the euro area in January continue to indicate the development of a recession. The most reliable business barometer for the euro area – the PMI index for the services sector – fell by 0.4 points to 48.4 points, marking the sixth consecutive announcement below the level of 50 points, which historically indicates a recession, according to this week’s analysis by the Croatian Employers’ Association.

The PMI index for the manufacturing industry rose to 46.6 points, where a recession is still expected in the production part of the economy.

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photo Eurostat, HUP

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At the same time, the German GfK consumer sentiment and IFO business climate index are recording further unexpected declines along with a worsening assessment of six-month expectations.

European companies have not yet fully ‘digested’ the cumulative increase in interest rates of 450 basis points, nor the permanent increase in energy prices, and are expecting weaker fiscal stimulus and a slowdown in demand from China, indicating further contraction of economic activities. Therefore, after a slight real decline in GDP in the euro area in the fourth quarter of -0.1% quarter-on-quarter, in the first quarter of 2024, HUP expects a somewhat larger reduction in economic activities.

The current recession could last through the first half of the year, after which no significant recovery should be expected as long as the ECB does not significantly lower interest rates. Therefore, in 2024, HUP expects de facto stagnation of the euro area economy (growth of barely 0.1%), while the German economy could decline by 0.3%.

Given the more permanent dampening effect of the mentioned negative factors on the economy, everything somehow ‘smells’ like the year 2000, when German companies were forced to deleverage, and the economy barely grew on average for four years, with mild recessions alternating with episodes of weak recovery.

The deteriorated business climate is likely to prompt a downward correction of the ECB’s macroeconomic projections in March, which could again strengthen speculation regarding the intensity of interest rate cuts this year.

So far, the recession has not affected employment thanks to strong demand for labor and rising wages, which, combined with strong corporate balance sheets, suggests a ‘shallow’ recession despite the strong rise in interest rates. Easing disruptions in foreign trade and new generation EU funds are also acting stabilizing.