The President of the European Central Bank (ECB), Christine Lagarde, managed to cover up any trace of a leak on Thursday. Absolutely impenetrable during the press conference, Lagarde He didn’t leave a single clue of what the central bank will do with rates at upcoming meetings. The Frenchwoman kept repeating the mantra “data, data, data” to set the course for upcoming meetings. This flaw was almost enough for analysts to conclude that the ECB will act calmly for the rest of the year and will not lower rates until December, almost assuming that a pause in reductions would be decreed at the October conclave. But this “slowness” of the coming months will have its counterpoint in 2025, some analysts warn: a “cascade” of rate cutseven more than the market expects, given the economic slowdown and its most painful seam, a patent deterioration of the labor market.
One of the analysts who most vehemently pointed out that ECB to open ‘sluice gates’ for cuts rate hikes next year is Mathieu Savary, chief European strategist at BCA Research and the creator of the term “cascade.” In a report on Friday, Savary points out that the strength of disinflationary trends and the negative turn in the macroeconomic situation They can let the market bet “short”which announces a rate cut (the ECB deposit rate remains the reference) to 2% in the summer of 2025 against the 3.5% decreed this Thursday (150 basis point cut, six 25 basis point cuts). Assuming that this year the rates will not fall again until December, the scenario envisaged by the operators would envisage up to five reductions in the first half of the yearThe fact that this number needs to be expanded justifies the use of the term “cascade”.
Savary explains that while persistent eurozone domestic inflation and abrasive services CPI justify the ECB’s caution this autumn, this is a “temporary” phenomenon, as, in his view, European margins are narrowing. The truth is that the contribution of unit profits to inflation in the economy as a whole has declined, from a high of 3.6% in the second quarter of 2023 to 1.1% in the first quarter of 2024. In addition, the contribution of labour costs has declined from 2.8% in the first quarter of 2023 to 1.5% currently.
The analyst firm also points to the goods sector as a source of disinflation for Europe: “Capacity utilization in the eurozone manufacturing sector has fallen back to the levels of the eurozone sovereign debt crisis. In Germany, it is back to the levels of the Great Recession.” At the same time, and as expected, Savary explains, the contribution of non-energy industrial goods to the overall CPI fell to 0.1%. At the same time, it continues, the contribution of energy prices to inflation has fallen back into negative territory thanks to weak oil prices.
On the other side of the equation, It is the labor market that re-emerges as the great catalyst for 2025. It is true that the Eurozone labour market is showing unusual resistance to headwinds. The unemployment rate remains at a historical low (6.4% unemployment), while wages continue to grow with some intensity. However, even if in the panoramic photo, seen from afar, not a single stain appears, if you look closely at the labour market and everything around it, you can see how some cracks and black spots appear.
“The outlook for the European labour market remains disinflationary. Growth in compensation per employee has already slowed at 4.3% and that of negotiated wages, at 3.6%. In addition, labor costs will continue to slow down in the coming quarters. The gap between labor supply and demand has been narrowing since March 2023. Job creation worsens; the employment component of the eurozone composite PMI index fell below the 50 line, confirming the slowdown in labor demand, job vacancies in France and Germany, two economies that account for almost half of eurozone jobs, fell by 30% and 22% respectively from their peak in December 2022,” Savary details.
The latest data published by Eurostat on vacancies reveal a worrying trend: France and Germany are among the two economies showing the sharpest declines, as Savary notes. These two countries alone account for almost 50% of the European Union’s GDP and exceed this figure if we only consider the eurozone. In the case of Germany, since late 2022 and early 2023, more than 700,000 job offers have “disappeared” (employers are slowing down hiring), while in France, around 150,000 have “evaporated”. What is happening in the economy for employment to start slowing down? slowdown in activity that threatens to turn into a recession.
Lagarde herself, in her speech, suggested that the economic slowdown was intense and coming from all possible fronts. Eurozone running out of growth engines It is therefore virtually impossible to keep afloat such a tight labour market, where productivity growth is conspicuous by its absence. The French have admitted that the weak growth of the economy (0.2% in the second quarter) is mainly due to the positive contribution of net exports and government spending. Both components should start to moderate sooner rather than later, which will lead to an exit from the eurozone. without growth “engines” and condemned to recession, the destruction of net employment would be the end result of this story.
The banker highlighted the loss of strength of these factors: “Risks to economic growth remain tilted to the downside. A decline in demand for eurozone exports, due for example to a weaker global economy or an escalation of trade tensions between major economies, would affect eurozone growth,” Lagarde commented.
On the other hand, the banker also admitted that “the private domestic demand (consumption and investment) weakened as households consumed less, businesses reduced business investment, and housing investment fell. Although services supported growth, industry and construction contributed negatively. “According to survey indicators, the recovery continues to face some obstacles.”
The euro area economy has a demand-side GDP structure typical of a developed economy. This means that private consumption accounts for around 60% (or more) of all output. The consumer confidence is backtracking again. The European Commission has published a preliminary estimate that consumer confidence in the euro area fell to -13.4 points this month, compared to -13 in July, a decrease of 0.4 points. On the other hand, the household savings rate is rising again (it has already accumulated three consecutive quarters of increases); precautionary saving could be one of the reasons;
Savary is not alone in dating this “availability” to 2025. “If we look at the ECB and use an assessment of how the eurozone economy will evolve in the coming months, we expect the central bank to eventually accelerate the pace of further rate cuts. Not this year, but next year. Why not this year? Because at present, German wage negotiations and rising sales price expectations continue to indicate a certain rigidity in the ECB’s inflation outlook. The rise in inflation is quite low, The ECB will want to be completely sure before embarking on more aggressive rate cuts,” Carsten Brzeski, strategist at ING, said in a note to clients.
However, Brzeski adds, “the weakening growth outlook for the eurozone should be the trigger for a more aggressive rate cut.” “Already in July, the ECB had changed the assessment of risks to its growth outlook to a downside trend. Given that the ECB’s forecasts have structurally overestimated the timing and strength of the eurozone economy, it seems that it is only a matter of time before a weaker growth outlook translates into more aggressive rate cuts, the soft landing in the US and its impact on the eurozone could be that trigger,” he warns.
“For now, we see an ECB Governing Council that will remain reluctant to accelerate the pace of easing until services inflation eases. But after that, a faster pace of rate cuts is likely. In practice, this means that the ECB is likely to Cut rates in 2025 more than the yield curve predicts in the short term, because the eurozone will experience a recession next year,” Savary believes.
“A recession will force the ECB to cut rates more than the market expects. According to a recent paper from the central bank, the real neutral rate in the eurozone is between -0.5% and 1.1%, with the median of all their models around 0.%. So, in nominal terms, the median estimate of the eurozone neutral rate is close to 2%. Interestingly, the short-term yield curve projects an official interest rate of 2% by July 2025, which means that Europe will achieve a soft landing. If the eurozone cannot avoid a recession, the ECB’s deposit rate will fall below this level.“, adds the BCA Research expert.
