The economy says goodbye to contraction

For the first time since May 2023, the final composite PMI climbed into expansion territory as the index rose to 50.3 in March. The increase was driven by higher new orders, Appendix of Future Publications and Works. Labor markets continue to be strong, with the unemployment rate at 6.5% in February. Coupled with recovering purchasing power this should set the scene for higher private consumption. However, we are yet to see private consumption pick up as retail sales eased again in February. The reason may still be very low consumer confidence. In general, recent data points to a stagnant economy that is gradually improving. This is attributed to rising services activity as the German economy continues to struggle as the manufacturing sector continues to struggle. However, the global production cycle is likely to recover, as indicated by recently higher metals prices, and 2024 should bring more benign activity. We got the first sign of this as German industrial production rose 2.1% m/m in February, the second straight month of growth.

Both headline and core inflation came in lower than expected in March, printing 2.4% y/y (pre: 2.6%) and 2.9% y/y (pre: 3.1%) respectively. Food inflation has picked up in recent months due to base effects, but finally eased to 2.7% (pre: 3.9%). Along with the drop in core inflation, this mainly drove the lower headline numbers. Staff projections should not have changed the ECB's view of March inflation as expected. Services inflation has stuck at 4% for the fifth consecutive month, and with current high wage growth, the fight against domestic inflation is far from over. On top of this, the timing of Easter seems to have affected inflation in March less than expected, and as Easter spreads into April, some of the effects may play out in the April mold.

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Euro area productivity fell by 1.0% y/y in 2023, resulting in an average growth rate half that seen in the US since 1995. Our forecasts suggest that this trend of slower productivity growth in the euro area relative to the US will continue, implying a structurally weaker EUR/USD and lower policy rates from the ECB. Research for more details Euro area – Euro area productivity continues to lag, 3 April.

We expect the ECB to provide a clear commitment to a June rate cut at its April meeting. However, we do not expect the ECB to provide any guidance on the pace of rate cuts beyond the June meeting due to sticky core inflation – see ECB Outlook for more details – due for a cut on 5 April.

After a decade of positive growth, European house prices fell by 1.1% in 2023. Unsurprisingly, the decline reflects the lagged effects of monetary policy amid the ECB's hiking cycle in recent years. However, the difference between major European economies is significant. House prices in Spain and Italy increased by 4.3% and 1.8% respectively, while German and French house prices fell by 7.2% and 3.6% respectively. This contrasts with the fact that mortgage rates have risen so much in Italy, for example. Instead, country-specific factors such as new housing supply and financial support measures are weighted in the figures.

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