The ECB is in a real bind.
European economic activity decelerated markedly in June, PMIs out Thursday showed. With policymakers poised to ratchet rates higher starting at next month’s meeting, efforts to clamp down on record-high inflation may throttle growth while doing little to address the proximate cause of rising prices. In short: Stagflation is all but inevitable.
The flash read on the bloc-wide gauge of services activity printed just 52.8 for June, down from 56.1 in May, nowhere near consensus and well below the most pessimistic estimate.
The manufacturing index, meanwhile, dropped to a 22-month low of 52 (figure above), matching the lowest projection from nearly three-dozen economists. It stood at 63.4 a year ago. New orders plunged to 44.7, the worst reading since the early days of the pandemic.
The composite gauge, at 51.9, touched the lowest levels since February of last year. New orders nearly slipped into contraction territory. Expectations deteriorated. Business confidence is indicative of an “imminent downturn,” the color accompanying the survey warned.
“Excluding pandemic lockdown months, June’s slowdown was the most abrupt recorded by the survey since the height of the global financial crisis in November 2008,” Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, said.
The early read on activity for June suggests the eurozone economy is growing at an anemic pace — just 0.2%. The worst, Williamson sighed, is “likely to come in the second half of the year.”
Needless to say, aggressive ECB hikes will serve as a drag on growth. Money markets priced 166bps of tightening by year-end as of Thursday, and that was after bets were trimmed. “The big drops in French and German PMIs and renewed fears of German energy shortages have caused a wholesale dovish repricing,” SPI Asset Management’s Stephen Innes said.
At this month’s meeting, officials confirmed their intentions to raise rates 25bps next month and all but pre-committed to a larger, 50bps, increment in September (figure below).
Already, the ECB’s plans to remove accommodation caused severe consternation in periphery bonds, forcing officials to call an emergency meeting and accelerate work on a so-called “fragmentation tool” aimed at capping spreads. Details remain sparse, in part because the ECB doesn’t want to give markets a target to shoot at and in part because the technical parameters are still being debated. Any purchases under the program would be sterilized to avoid offsetting the bank’s efforts to tighten policy.
German bond yields plunged Thursday, as country-level PMIs missed estimates and Economy Minister Robert Habeck warned of a “Lehman effect” from the worsening energy crisis.
“Germany’s economy has lost virtually all the momentum gained from the easing of virus-related restrictions, with growth in the service sector cooling sharply for the second month in a row in June, but perhaps the biggest cause for concern is a broad-based decline in demand, with a deepening downturn in manufacturing new orders coinciding with a first fall in service sector new business for six months, as rising prices and elevated levels of uncertainty take a toll,” Phil Smith, Economics Associate Director at S&P Global Market Intelligence, said.
PMIs for France were likewise lackluster, adding to market angst during a week when domestic political concerns took center stage after a legislative setback for Emmanuel Macron raised the specter that France could become “ungovernable,” to quote a few hyperbolic takes.
In any case, the bottom line on Thursday was simple enough: Survey data for June suggests the economy is downshifting rapidly, putting the ECB in the (very) awkward position of recession accelerator.
“For the ECB, today’s PMIs paint a very clear picture of cooling demand,” ING’s Bert Colijn remarked. “Just weeks before the first rate hike in more than a decade, demand has already slowed markedly.”
