Euro facing worrying signals for German economy

Euro facing worrying signals for German economy
Germany's economy 

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The euro faces headwinds for further progress amid a noticeable slowdown in the eurozone's largest economy and expectations of a negative event from the European Central Bank on Thursday.

The October ECB meeting ends Thursday and economists say policymakers will communicate that the bloc's economy continues to need generous monetary terms; such a position, while supporting the economic outlook, is generally interpreted by strategists as being weighted around the euro.

Such a result from the ECB is all the more certain given that Germany's most-observed leading indicator - the Ifo business climate index - fell for the fourth month in a row in October.

The Ifo stood at 97.7 versus 98.9 in September, a sign that the economy is entering a significant slowdown.

"The risk that the economy will stagnate in the fourth quarter is high," says Carsten Brzeski Global Head of Macro at ING Bank. "The growing excitement of the summer months has completely evaporated."

The survey shows that the largest economy in the euro area is plagued by supply problems and that capacity utilization in manufacturing is falling.

The euro-dollar exchange rate fell 0.20% to 1.1624 earlier this week, slowing the euro’s recent rally.

In response, the pound's exchange rate against the euro climbed to 1.1823, allowing the pound to halt its recent decline against the common currency.

"The sand in the wheels of the German economy is hindering recovery," said Clemens Fuest, President of the Ifo Institute.

"This is a worrying signal for the German economy," said Claus Vistesen, chief economist of the euro zone in the Macroeconomics Hall of Fame.

"The IFO expectation indicator is one of the best short-term leading indicators we have in Germany and it currently points to a sharp decline in short-term momentum as the reopening wave subsides," he adds.

The report is a highly regarded leading indicator of economic development in Germany and is based on around 9,000 monthly surveys of companies in the manufacturing, service, construction, wholesale and retail sectors.

"A clear risk for the German economy would be a sharp decline in incoming orders due to bottlenecks," said Brzeski.

Like other global economies, Germany is confronted with persistent friction in its supply chain, rising gas prices and rising input inflation.

Brzeski says a positive side to the dire outlook is that the ingredients for a strong recovery remain; These include well-filled order books, low inventory levels in manufacturing, a strong labor market and excessive consumer savings.

Pantheon Macroeconomics forecasts third-quarter GDP data for Germany on Friday will show 2.0% quarter-over-quarter growth, after a 1.6% increase in GDP in the second quarter mainly driven by strong services is.

Your baseline for the fourth quarter is a 0.7% increase over the previous quarter.

But the ifo indicator "is now warning us that this could be far too optimistic," says Vistesen.

In light of the slowdown, the ECB will stress that it will continue to offer cheap interest rates and generous quantitative easing.

The ECB should push back market expectations that there could be a rate hike as early as the end of 2022 and claim that 2024 is a more realistic target.

Expectations of an earlier rate hike are evident in money market prices and reflect investors' belief that global central banks will respond to the rise in global inflation by raising interest rates.

This appreciation by the markets will have provided some support for the euro lately and may explain why it has appreciated against the dollar over the past few weeks.

The resilience of the euro, meanwhile, disappointed the sterling bulls, who would have liked to see the GBP / EUR rise further after an aggressive reevaluation of the Bank of England's rate hike intentions.

Some economists expect the ECB to oppose this market appreciation, thereby threatening the recent robustness of the euro.