Europe's Top Economies Face Tough Time at the Start of 2024

(Bloomberg) -- Private-sector activity in the euro area contracted for an eighth month in January, a weak start to the year after a likely second-half recession.

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Data Wednesday showed S&P Global’s purchasing managers’ index inched up to 47.9, just shy of the 48 predicted by economists and the closest to the 50 level that marks expansion since July. That improvement was down to manufacturing, which jumped to a 10-month high, while services defied analyst expectations and dropped.

The numbers come less than a week before fourth-quarter output readings are due, which are likely to show that the 20-member bloc was in recession. While a revision of previous data means Germany probably avoided such a fate, some economists still predict that the start of 2024 will see another contraction in the region’s biggest economy.

Germany’s January PMI data remain bleak, with both it and France having a difficult start to the year.

Business surveys by S&P Global showed the downturn in the two countries in the second half of last year continuing at a slightly steeper pace in January, while economists had predicted the situation would improve somewhat. Neither manufacturing nor services managed to return to levels indicating growth.

Gains across euro-area bonds picked up after the data. Germany’s 10-year yield fell 6 basis points to 2.30%, with the equivalent French yield posting a similar move to 2.79%.

“When assessing the performance of Germany and France, it is only a question who is having the tougher time,” said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, adding that manufacturing puts Germany in a slightly better position than France.

“One plausible explanation is that the external environment beyond the euro zone is showing signs of improvement, providing Germany, with its substantial export exposure, a relative advantage,” he said.

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In Germany, inflows of new work decreased for a ninth month as customers remained hesitant due to high financing costs and geopolitical uncertainty. The country had a “sluggish start to the new year,” de la Rubia said.

“Services activity has not only declined for the fourth consecutive month but has also accelerated in its downturn,” he said. “Manufacturing, remaining in recessionary territory for the 19th straight month, has displayed a somewhat softened downturn.”

Output in Europe’s largest economy probably shrank 0.3% in the fourth quarter, according to a preliminary estimate released last week. More data for that period, also for the French economy, are due on Jan. 30.

The crisis in the Red Sea, forcing ships to make a detour around Africa, is having a detrimental impact on supply chains in the manufacturing sector, according to S&P Global. The effect on prices was limited, however, suggesting “transport expenses may not wield overwhelming influence yet over the aggregate unit costs of the myriad consumer goods traversing this route,” de la Rubia said.

A separate survey of UK private-sector firms showed the sharpest jump in costs in five months and the first lengthening of suppliers’ delivery times in a year due to the Red Sea disruption. Still, S&P Global also pointed to a brightening economic backdrop, with a likelihood the UK will avoid a recession.

Read more: UK Inflation Worries Back With Signs Red Sea Attacks Lift Prices

Overall cost pressures remained elevated in both France and Germany, particularly in the services sector, where quickly rising labor costs are playing an outsize role. That’s an issue that European Central Bank officials recently emphasized, and they will probably do so again when they meet to set policy this week.

Traders added to the extent of monetary easing they expect from the central bank this year following the PMI data, with 136 basis points priced by year end, according to swaps. Still, that’s less than the near 170 basis points that were priced at the end of 2023.

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“The euro-area composite PMI will probably make the European Central Bank think that resisting interest-rate cuts until June is the right course of action. The survey suggests the economy of the monetary union isn’t collapsing under the weight of higher borrowing costs, despite weakness in the bloc’s two largest economies, and inflation is proving difficult to tame”

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“The weakness of the headline indices coupled with evidence of persistent cost pressures are hardly encouraging for the ECB ahead of tomorrow’s policy meeting,” said Valentin Marinov, head of G10 FX strategy at Credit Agricole. “In particular, it would be interesting to see for how long can the Governing Council ignore the weak PMIs in its quest to tame inflation.”

According to anecdotal evidence in France, “input prices rose due to higher wages, confirming the concerns that ECB members have over cutting interest rates early,” said Norman Liebke, an economist at Hamburg Commercial Bank. “Companies have largely been able to pass on their costs to customers, therefore explaining the increase in selling prices.”

US PMI data due later on Wednesday are predicted to show continued expansion. Earlier figures from Australia revealed an easing slump, while Japan saw growth.

--With assistance from Joel Rinneby, Mark Evans and Alice Gledhill.

(Updates with UK PMI data in 13th paragraph, updates with Bloomberg Economics comments after 15th paragraph.)

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