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Eurozone on the right track for a soft landing

ECONOMYEurozone on the right track for a soft landing

While private consumption and investment remain weak in the eurozone, the labor market is exceptionally strong, with real incomes growing. This bodes well for private consumption in the future.

Moreover, January’s PMI indices suggest a slowdown in the recessionary momentum, as manufacturing sector activity improved to its highest reading in ten months. Price indicators also suggest a slight risk of deflation in the eurozone. However, with stable energy prices, Allianz Trade still expects deflation to accelerate, possibly allowing the ECB to lower interest rates for the first time in July and providing some tailwind in the second half of this year.

The tightening peak has passed, as suggested by the latest ECB survey on bank lending.

A likely technical downturn in the second half of 2023 will not negate Allianz Trade’s forecast for a gradual recovery in economic activity in 2024. Eurozone GDP data for Q4 2023, to be presented this week, are expected to show another downturn, potentially confirming a technical recession after a -0.1% drop in Q3. This concerns us as the region will have been in stagnation for five consecutive quarters. Private consumption and investment remain low, heavily affected by high interest rates and the ongoing strain from falling real wages. However, Allianz Trade does not foresee a deeper recession and still maintains our forecast of a slow rebound in economic activity in 2024.

First, the labor market remains very strong, with unemployment at an all-time low of 6.4%. Additionally, real incomes are set to rise as deflation continues, which will eventually revive private consumption.

Second, the output gap is currently significantly negative. As we see no changes in potential growth, production must mechanically catch up to its potential level at some point.

Finally, the ECB is likely to lower interest rates in the summer in response to ongoing deflation.

Overall, the eurozone economy is facing several headwinds, but there are also some positive signs. Allianz Trade expects a gradual recovery in economic activity in 2024, supported by a strong labor market, deflation, and potential monetary policy easing.

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