The European Central Bank (ECB) wanted to use logic to put an end to historic levels of inflation. Raise rates to contract demand and activity levels, so that the economy cools down and prices fall due to inertia. And do it without overdoing it. The problem is that it seems to have done it… And inflation remains high, with food and energy prices skyrocketing. Stagflation – low or no growth with high inflation – rears its head. They are mainly concerned about Germany and France and the contagion in the services. It is a gloomy scenario that once again raises the dilemma of whether or not to continue raising rates.
The thermometer that measures activity, orders, employment, stocks or deliveries, the PMI index, gave worse data than expected yesterday. The general index of the euro zone marks 47 points in August – below 50 is a contraction – it falls almost two points. A minimum since November 2020. Pandemic aside, it is the worst level since 2013. Manufacturing continues in negative territory (43.7) and, to top it off, services enter contraction (48.3 by 50, 9 prior) for the first time in 2023.
Business costs, including wages and what they charge for their products, are rising, orders are deteriorating and expectations are worsening. “The impact of a tighter monetary policy continues to hold back demand and, while energy deflation is underway, prices remain very high. The inflation battle is far from over,” said Rory Fennessy, from Oxford Economics. The chances of a contraction rise in the third quarter: “The situation is likely to get worse before it gets better,” he said. S
Germany, which is pointed out as an obstacle, and France are of particular concern. The first sees its index fall four points, up to 44.7. The contraction in services reaches the levels of May 2020. Without a pandemic, it is at 2009 figures. The combination of rising costs, uncertain demand, fewer orders, widespread pessimism… “Any hope that services would rescue the economy it has evaporated”, it was pointed out in the note of the data. France remains unchanged (46.6), but anchored in contraction. Their evils, similar…
Services, called to be the engine of growth this year, disappoint. As a result, employment has slowed down in general. It falls in manufacturing and in services, hiring slows down. The fear of over braking is already on the table. “The weakening of services could reveal that monetary transmission (the transfer of high rates to the real economy) is stronger than the hawks expected,” commented Rosa Duce, head of investments at Deutsche Bank. A few months ago industry was the sick one, now so are 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 hike justified by inflation (to 5.5%) may be more damaging than anything. “Stiff underlying and wage pressures seem to call for a bigger (rate) adjustment, but much weaker activity data suggests otherwise,” said HSBC’s Dominic Bunning. Analysts’ comments yesterday were in the same direction. The ECB has ordered “aggressive monetary policy that risks further slowing the economy, a turn in interest rates is essential to return to the evolution of growth”, insisted Max Wienke of eToro . ECB President Christine Lagarde could clarify doubts at the Jackson Hole meeting on Friday. Rates are at 4.25% and the chances of another 25-point hike have fallen from more than 50% to 40%, according to Reuters.
Stock markets deflated after the data, with minimal final gains. The euro also suffered and lost 0.4% against the dollar, but recovered.
