The European Central Bank (ECB) wanted to use logic to end historical inflation levels. Raise rates to contract demand and activity levels, so that the economy would cool down and reduce prices out of inertia. And do it without going overboard. The problem is that it seems to have done so... and inflation remains high, with food and energy prices giving scares. Stagflation –low or no growth with high inflation– looms. They are especially concerned about Germany and France and the contagion to services. Gloomy scenario that raises the dilemma of continuing to raise rates or not.
The thermometer that measures activity, orders, occupation, stocks or deliveries, the PMI index, has produced worse than expected data this Wednesday. The general index of the euro zone marked 47 points in August –below 50 is contraction–, falling almost two points. A minimum since November 2020. Pandemic aside, it is the worst level since 2013. Manufacturing remains in negative territory (43.7) and to top it off, services are contracting (48.3 compared to the previous 50.9) for the first time in 2023.
Business costs, salaries included, and what they charge for their products increase, orders deteriorate and therefore expectations worsen. “The impact of tighter monetary policy continues to dampen demand and while energy deflation is underway, prices remain very high. The inflation battle is far from over,” said Rory Fennessy of Oxford Economics. And the chances of a contraction in the third quarter are rising: "It is likely that the situation will get worse before it gets better," he said. S
Germany, who is targeted as a ballast, and France are especially worrying. The first sees its index drop four points, to 44.7. The contraction in services has reached levels of May 2020. Without a pandemic, we are in figures for 2009. Rising costs, uncertain demand, fewer orders, general pessimism are combined... "Any hope that services will rescue the economy it has evaporated”, was noted in the data note. France remains unchanged (46.6) but stuck in contraction. Their ills, similar...
Services, called to be the engine of growth this year, disappoint. As a consequence, employment has generally slowed down. In manufacturing it falls and in services hiring slows down. The fear of having gone too far is already on the table. “The weakening in services could reveal that monetary transmission (the passage of high rates into the real economy) is stronger than the hawks expected,” said Rosa Duce, chief investment officer at Deutsche Bank. In previous months the industry was the sick, now also the services. The contagion spreads.
The outlook casts doubt on the ECB's strategy, because prices remain high and activity is contracting more than expected. At the September meeting, another rise justified by inflation (at 5.5%) may be more damaging than anything else. “Tough core and wage pressures appear to call for further (rate) adjustment, but much weaker activity data suggests otherwise,” said HSBC's Dominic Bunning. Comments from analysts were in the same direction. The ECB has commanded "an aggressive monetary policy that risks slowing down the economy even more, a turn in interest rates is essential to return to the path of growth," insisted Max Wienke, from eToro. Doubts could be cleared up by ECB President Christine Lagarde on Friday at the Jackson Hole meeting. Rates are at 4.25% and the chances of a further 25-point increase have fallen from more than 50% to 40%, according to Reuters.
The stock markets deflated after the data, with minimal final rebounds. The euro also suffered and fell 0.4% against the dollar, but recovered.
