Euro area recession risks grow as inflation falls sharply – ANZ

Data are confirming a progressive and sustained improvement in EA inflation. In the near term, the risks to underlying price pressures appear tilted to the downside as the lagged effects of earlier monetary tightening and faltering economic activity weigh.

Despite these downside pressures, we estimate if current monthly core HICP trends continue through 2024, inflation will converge on target earlier than the European Central Bankis forecasting.

Economic data are confirming that monetary tightening is working effectively. GDP growth is flatlining,which partly owes to higher interest rates, tighter bank lending conditions and weakening credit growth. M3 money supply fell 1.2% y/y in September, meaning annual growth is negative in real terms when inflation is taken into account. Our calculations estimate that the stock of real M3 is now only 3.0% above pre-COVID levels. Credit growth to non-financial corporates (NFC) has also slowed sharply (September 0.2% y/y) and is negative in real terms. In its short history, the EA has not escaped recession during sharp credit downturns.

Activity data disappointed at the start of Q4. The composite flash PMI fell 0.5pts in October to 46.5, its lowest reading since the war in Ukraine started and the lowest level since November 2020 when the economy was partly shuttered because of COVID. The composite PMI is now hovering at levels when the EA was hamstrung with the debt crisis following the GFC. Historically, this gauge of economic activity hasn’t really been lower other than during the GFC and pandemic. It is reflecting difficult economic conditions for manufacturing and increasingly so for services.

The weakness in China’s recovery is also contributing to weak export demand. In the first eight months of this year, exports to China fell 0.7% y/y. China is the European Union’s second largest export destination. Exports to other major Asian partners over the same time are also weak. Exports to Japan have fallen 5.5% y/y and to South Korea they are down 1.8% y/y. They each account for roughly 25% of the export volume to China.