‘Sick Man’ Germany Drags Europe Into ‘Ugly’ Stagflation

Europe is on the brink of recession. Or still in a recession. Either characterization will probably work.

If it feels to you like the bloc is experiencing a kind of intractable, rolling downturn, you’re not wrong. Germany in particular is suffering from just that sort of interminable malaise, dubbed a “slowcession” by one bank last month. Preliminary PMIs for the region released on Wednesday underscored the point.

“Any hope that the services sector might rescue the German economy has evaporated,” Cyrus de la Rubia, Chief Economist at Hamburg Commercial Bank which produces the PMIs in conjunction with S&P, said.

The flash read on the services PMI for Germany in August was just 47.3, a nine-month low and a remarkable drop from the prior month’s 52.3.

That decline was a veritable gut punch. “The downward pressure on the eurozone economy stems mainly from the German services sector,” de la Rubia remarked, describing the rapidity of the deceleration in German services activity as “unusual.” “This will only fuel the discussion of Germany being the sick man of Europe,” the release added.

The bloc-wide composite gauge printed 47. That counted as a 33-month low, marked the fourth straight monthly decline and was the worst reading in a decade if you exclude the pandemic.

A contractionary 48.3 print on the services gauge for the bloc was the first since December. Although the bottom might be in for manufacturing, “a real turnaround” probably isn’t on the cards until early next year, de la Rubia suggested. In other words: Not quick enough to rescue the broader economy from a services slump.

The figures were indicative of a 0.2% contraction for the eurozone this quarter.

The color accompanying the releases, which also included across-the-board contractionary prints for France, was unequivocal: Stagflation is a reality in Europe. Average input prices and prices charged rose for both goods and services.

“Christine Lagarde sounded the alarm that the economy may be faced with higher wages and lower productivity, leading to higher inflation,” de la Rubia went on. “It seems like those worries are about to turn into reality, at least for the vast services sector.”

The ECB is grappling with price pressures that are pretty clearly embedded in wage-setting. Services inflation rose again in July to 5.6%. As I put it late last month, the steady grind higher in services price growth is vexing. The favorable YoY comps that are pushing down the headline rate won’t last forever. At some point, underlying inflation needs to show signs of moderation and that depends heavily on the interplay between wages and prices charged for services.

The read-through: The ECB will have a difficult time justifying a pivot to more accommodative rhetoric following the most aggressive hiking cycle in the institution’s short history, even as the drag from that tightening weighs on growth.

“There is very little to like about today’s PMIs,” ING’s Bert Colijn lamented. “While goods inflation is easing on the back of lower costs and weak demand, services inflation remains elevated for now due to increased wage cost pressures — despite weakening demand.”

De la Rubia drove it home. “Stagflation is an ugly thing [but] it’s exactly what is happening to the services economy, as activity has started to shrink while prices have shot up again,” he sighed.