Eurozone – Coming to a Halt!

The ECB, who had ‘gung-ho’ with the July rate hikes, and now want to prevent any extra rate increase. The strong euro and a slight rebound in oil prices added fuel to the rout. The PMI index fell to below 47 in July for manufacturing and 48.3 for services suggests that purchasing managers in the Eurozone have become much more pessimistic. Technically speaking, every reading below 50 means that the PMI respondents are seeing a contraction. Consumers in the Euro-zone, like their counter-parts in the U.S. are expressing their lowest level of confidence in years.

German, the biggest economy in the Eurozone, is showing signs of weakness as businesses scaled back their expectations for the next 6 months. The Ifo business confidence index fell sharply to 97.5 in July from 101.2 in June – the biggest monthly decline since the recession in 2001, suggesting that businesses are highly likely to slash their investment and hiring plans accordingly. This is not unique to German. France’s business confidence inxed also fell to 98 in July from 101 in the previous month. Similar observation is made for Italy. If this trend continues, I expect the ECB to once again revise its growth outlook in September, and that will raise the risk of semi-stagflation instead. The risks of one or two quarters of negative GDP growth are rising and I see a 45% probability of a recession in the Eurozone. Such an outcome would be very significant for the monetary policy debate within the ECB Governing Council.

Fiscal policy will only marginally cushion the negative shock on purchasing power as the industry is particularly sensitive to the strong Euro. Unfortunately for the Eurozone economies, the most obvious source of hope is something over which it has no control whatsoever – the oil market. If oil prices continue to correct at the same pace as they have done these last days, consumers could find some breathing space.