European, German industrial fatigue endures, cannot be blamed on ‘energy anymore’

Industrial activity in the eurozone continued to contract in July, a closely-watched business survey confirmed on Thursday (1 August), as Europe’s economic woes showed little sign of abating despite growth data slightly above analysts’ forecasts earlier this week.

The latest HCOB eurozone manufacturing Purchasing Managers’ Index (PMI), which measures the overall health of factories across the single currency area, held steady at 45.8 last month – slightly above the 45.6 reported in last week’s flash estimate but below the 50-point mark that separates growth from contraction.

Germany, the bloc’s largest economy, posted a three-month low in its manufacturing index, sliding from 43.5 to 43.2 from June to July. This follows weaker-than-expected GDP growth for the country, -0.1% rather than the previously forecast +0.1%, published by the EU’s statistics office Eurostat.

The news increased fears that Germany could be heading for a technical recession (which is defined by at least two consecutive quarters of negative growth) just months after exiting its 2023 economic slump, when it posted the worst performance worldwide.

Sander Tordoir, chief economist at the Centre for European Reform (CER), said that Germany’s industrial malaise can no longer plausibly be attributed to the spike in energy prices triggered by Russia’s full-scale invasion of Ukraine in February 2022, as energy costs are now broadly similar to what they were prior to the Covid-19 pandemic.

“I think it will take time to disentangle what the factors are, but it is also very clear it cannot really be energy anymore,” Tordoir told Euractiv.

Tordoir suggested that likely causes of Germany’s industrial decline include slowing domestic and external demand as well as growing competition from China, which is increasingly prioritising the export of cutting-edge manufactured products.

“China’s manufacturing export surpluses are way higher than before the pandemic, and they tend to be in Germany’s sectors, most of all cars. So to my mind, that must be a big part of the puzzle,” Tordoir said.

Production hit across the board – yet tougher times ahead?

Meanwhile, France, the eurozone’s second-largest economy, registered an even steeper PMI drop, from 45.4 to 44: a six-month low, and a fraction beneath last week’s flash estimate of 44.1.

“Industrial activity in the eurozone took a hit across the board in July,” Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, said in a statement.

He added that the survey data showed that only Greece and Spain posted “meaningful growth” in factory activity last month – but warned that “even there, momentum has slowed significantly”.

“The widespread and steep downturn is surprising, making it more likely that the manufacturing sector will face tough times in the coming months,” de la Rubia said.

Modest growth uptick …

The PMI data follows the Eurostat report showing an upward tick in the eurozone growth rate, despite the German slowdown: the 20-member states region posted a quarterly GDP increase of 0.3% in the second quarter of this year, above analysts’ expectations of a 0.2% expansion.

Tordoir said that Europe’s better-than-expected GDP data was largely a result of strong growth in Spain, the eurozone’s fourth-largest economy, which beat analysts’ expectations of a 0.5% expansion to grow by 0.8%.

“Spain is now the [eurozone’s] bright spot,” he said. “It is part of the reason why the eurozone average came out at 0.3% and not 0.2%.”

… and hotter-than-expected inflation

Eurostat also reported this week that eurozone inflation grew from 2.5% in June to 2.6% in July, above analysts’ expectations of a drop to 2.4%.

Core inflation was also higher than expected at 2.9%, the same as in June.

Germany and France’s inflation rates both ticked upwards from 2.5% to 2.6%.

Carsten Brzeski, global head of macro at ING, said that the recent data is overall “better than feared” but nevertheless fails to paint “a rosy picture for the eurozone”.

“I think the message is one of sticky inflation [and] sluggish growth,” he told Euractiv.

A trend of downplaying ECB rate hawkishness?

Brzeski also noted that the current inflation data suggests markets’ pricing in of a two-third probability of a rate cut at the ECB’s next meeting in September is “slightly too optimistic”.

“To me, the September [decision] is really completely undecided. I would really go for 50-50,” Brzeski said.

Tordoir agreed: “There’s a pattern here of underestimating the ECB’s hawkishness,” he said, referring to markets’ overoptimistic outlook at the start of this year when rate cuts in March and April were anticipated that never transpired.

The ECB hiked its key interest rate from negative levels to a record high of 4% to dampen soaring price pressures triggered by Russia’s invasion, which caused eurozone inflation to peak at 10.6% in October 2022. The ECB’s target rate is 2%.

The bank cut rates to 3.75% in June but held them steady in July, amid persistently strong wage and services inflation. ECB President Christine Lagarde said last month that September’s decision was still “wide open”.

[Edited by Anna Brunetti/Chris Powers]

Read more with Euractiv