Weak production data pours cold water on Eurozone’s hope for industrial recovery

A sharp plunge in industrial production data suggests that the initial signs of an inventory cycle turn were mainly driven by US frontloading rather than a genuine cyclical recovery. Industrial weakness looks set to continue.

Just-released macro data for the eurozone provides both a look in the rear-view mirror as well as a view through the side window. And the picture we are seeing is one of fading industrial resilience and stark divergence across the eurozone.

The look in the rear-view mirror shows a relatively resilient eurozone economy in the second quarter, after the US frontloading boost in the first quarter. GDP growth was confirmed at 0.1% quarter-on-quarter, from 0.6% QoQ in the first quarter. However, the eurozone economy is anything but synchronised currently, with GDP growth ranging from -1% QoQ in Ireland and -0.1% QoQ in Germany and Italy to 0.6% QoQ in Spain and 0.7% QoQ in Portugal.

Looking through the side mirror, however, paints a less favourable picture as industrial production plunged by 1.3% month-on-month in June, from +1.1% MoM in May. On the year, eurozone industrial production was only marginally up. With today’s data, the strong surge in the first quarter due to the US front-loading of eurozone goods ahead of higher tariffs has basically been reversed entirely.

When looking at eurozone countries and developments since the start of 2020, structural shifts in intra-eurozone competitiveness as well as sector-specific specialisation become very clear. While industrial production in Germany and Italy remains more than 10% and 5% below January 2020 levels respectively, Ireland has seen a sharp surge, and countries like the Netherlands and Belgium have also recorded solid gains. Drivers behind these shifts are energy costs and competition from China.

Inventory cycle turning has become more uncertain again

Looking ahead, the eurozone manufacturing sector remains highly affected by two main, rather opposing, factors. While tariffs and the stronger euro will continue to weigh on the manufacturing sector, the gradual cyclical turning of the inventory cycle as well as the structural shift towards defence should support growth ahead.

The most problematic part of the forecast is the cyclical turning of the inventory cycle. After huge stockpiling in 2021 and 2022 and high inventories limiting production since then, the inventory cycle showed clear signs of turning in the first few months of the year. With the latest data, however, this turning of the inventory cycle seems to have been mainly driven by US frontloading and not by a genuine cyclical turning. In fact, at least at face value, today's industrial production data suggest that earlier signals of a turning inventory cycle currently rather look like a false start. The hoped-for industrial recovery seems to be delayed once again.

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