Dec 4 / Victor Arduin

Macroeconomics Weekly Report - 2023 12 04

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"Europe has good news to celebrate. Inflation in the region is nearing the European Central Bank's (ECB) 2% target as showed by Eurostat. Inflation fell to 2.4% in December, below analysts' expectations of 2.7%."

Inflation surprises in Europe, but the continent faces challenges

  • A big surprise, inflation data for the eurozone showed significant improvement in November, falling to 2.4%. Additionally, the core inflation rate, a key indicator for ECB decision-making, also fell below expectations, to 3.6%.
  • The markets are quickly pricing in a scenario of interest rate cuts on the horizon, with European bonds falling and stock indexes reflecting greater confidence.
  • However, victory over inflation is not yet guaranteed, and monetary authorities have been cautious, not ruling out further increases if necessary.


Europe has good news to celebrate. Inflation in the region is nearing the European Central Bank's (ECB) 2% target as showed by Eurostat. Inflation fell to 2.4% in December, below analysts' expectations of 2.7%. A key driver of inflation, energy, continues to experience significant year-on-year declines, reaching -11.5%.

With prices on a more moderate track, speculation about when the central bank will start to cut interest rates is increasing. The continent's economy is struggling to avoid a recession.

However, there are still inflationary risks to be considered. The labor market in the continent remains resilient, while an escalation in energy prices could pressure inflation in the continent.

Image 1: Inflation - Europe (%)

Source: IBGE

Image 2: Euronext Index vs Euro 2Y bond (%)

Source: Refinitiv

The outlook for 2024 remains challenging, but its improving

The Eurozone risks entering a recession later this year, accordingly to Eurostat data showing a slight decline in third-quarter output. This follows a meager 0.1% growth over the past year. Despite a slight improvement last month, the continent's PMIs remain in contractionary territory, further exacerbating concerns.

Part of the problems that hinder a more accelerated recovery of the eurozone is structural. An aging population, low productivity gains, and high bureaucracy compared to other developed economies are some examples. Therefore, it is not only the high interest rates that are hampering the economy, despite being the main vector of expectations at the moment.

Image 3: Unemployment Rate – Europe (%)

Source: Refinitiv

However, it is important to also observe the positive data that is emerging. Inflation improved substantially in the latest reading, above expectations, while the labor market remains resilient. This should help to improve demand in the continent, primarily by improving real wage gains and confidence. All of this considering highly restrictive interest rates for developed countries.

Furthermore, the energy landscape in Europe is significantly better compared to one year ago, following Russia's invasion of Ukraine. The EU achieved its 90% gas storage target on August 16th this year, 11 weeks ahead of the EU-mandated deadline of November 1st.

The continent is one of the regions that depends the most on externally-sourced energy. Supply disruptions of energy commodities such as natural gas, crude oil, and refined products always pose a risk to the continent's economy.

Image 4: Europe PMIs

Source: Refinitiv

Bonds turn around with a better inflation landscape

The European bond market reacted positively to the improved inflation outlook, with yields on two-year and ten-year bonds dropping by 13.37% and 10.70%, respectively, last week. This reduction in the spread between different maturities is a positive sign for the European economy, which can boost confidence among investors.

Despite still facing considerable risks, expectations that the ECB has reached terminal rates and may potentially cut interest rates next year are positive signs.

Image 5: Euro Bonds (%) and Spread 2Y-10Y Bonds

Source: Refinitiv

In Summary

Currently, oil prices are at much lower levels than observed weeks ago. However, events that cause disruptions to supply are a risk to be considered, such as the conflict between Israel and Hamas, which could escalate.

In general, looking at labor market data and growing confidence in the continent, as reflected in the stock market, it is possible that Europe will avoid a severe recession next year.

Even so, the continent faces a major challenge of reforms to be made to gain more competitiveness and productivity. Without these reforms, it is unlikely to have higher growth in the coming years.

Weekly Report — Macro

Written by Victor Arduin
Reviewed by Livea Coda


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