Eurozone - A gold medal boost masks underlying weakness; slowing wage growth seals ECB cut

While a pullback from this one-off is expected in September the figure already masks an underlying trend of weakening activity, especially in manufacturing and in Germany (more below). We still expect eurozone growth to be 0.3% q/q in Q3, reflecting the current strength in services, with growth slowing to 0.2% q/q in Q4. Today's numbers suggest the slowdown in growth might start sooner. The PMIs add to the growing divergence between manufacturing and services activity. The eurozone services PMI increased from 51.9 to 53.3 with the new business and - due to strong demand - output price subcomponents rising. Since February the services sector has carried overall activity and the difference with the manufacturing sector has widened. Indeed, also in August the manufacturing PMI slipped further into recessionary territory from 45.8 to 45.6. In the first few months of the year the eurozone manufacturing sector seemed to bottom out. But recently that optimism has faded. The decline was visible in both France and Germany, with the German manufacturing PMI now below the neutral 50 for a record 26 consecutive months in a row. Looking at the details, in both France and Germany a lack of demand is causing the manufacturing PMI to edge down. So far, the bottoming out in world trade has not yet led to rising demand for eurozone manufacturing exports. Partly as past shocks to competitiveness are still affecting market shares of eurozone exporters and high interest rates are negatively affecting demand (see our May Global Monthly for more on this).

Slowing wage growth seals September rate cut – ECB negotiated wage growth published this morning slowed sharply to 3.6% y/y in Q2, down more than 1pp from 4.7% in Q1. According to the ECB’s forward-looking wage tracker, a decline was expected in Q2, although the extent of the decline looks to have been somewhat larger (the ECB does not publish exact numbers, but we estimate that it expected a smaller decline to around 4%). Given the heightened sensitivity around wage developments, with lingering worries among some Governing Council members that high wage growth may become entrenched – which would keep inflation above the 2% target – today’s news served as an important confirmation that the disinflationary process remains on track. Looking ahead, the ECB’s tracker suggests negotiated wage growth may rebound somewhat in the second half of 2024, reflecting a continued backward-looking catch-up in purchasing power after the inflation surge of 2021-22. However, data for new jobs vacancies from Indeed continues to point to moderating wage growth in the eurozone (even if progress has slowed recently), and the softening labour market – combined with well-anchored inflation expectations – should drive a further normalisation in wage-setting behaviour over the coming quarters.

The case for less restrictive monetary policy continues to strengthen – The eurozone recovery is still struggling to gain momentum – dragged down by persistent weakness in manufacturing, especially in Germany (see above) – and the disinflationary process proceeding broadly as expected. Following an expected 25bp cut at the 12 September ECB meeting, we continue to expect a further two 25bp cuts before the end of 2024. After which the ECB continues cutting at a steady once-per-meeting pace until the deposit rate reaches 1.5% in Q3 2025. Market pricing previously pointed to only two further rate cuts this year and a slower pace of rate cuts in 2025, but has since moved closer to our view, with 68bp in rate cuts now priced before end-2024. Our base case sees 75bp in cuts.