Eurozone:  A minor contraction in the economy for H2 2023 – Danske Bank

Analysts at Danske Bank project a minor contraction in the European economy during the second half of 2023. They argue that the disinflationary process is underway, but not enough for the European Central Bank (ECB) to be confident in the timely return to the 2% target. 

Bye-bye two speed economy. Hello contraction

The August PMIs painted a gloomy picture following the also weak July print. Service PMI dropped to a 30-month low of 48.3, entering contractionary territory, while the manufacturing sector continued to register declining activity. The releases conclude the end of the two-speed economy with the service sector paving the way for benign growth, while the manufacturing sector struggled.

The drag in European business activity mainly attributes to the downturn in Europe’s largest economy – Germany - where activity declined at a 3-year high pace. The worsening of euro area activity should be seen as a feature rather than a bug given the ECB’s tightening mode the last year.

The risk is that activity suddenly declines too fast. Going forward, we expect a small contraction in the euro area GDP in H2 2023, partly driven by the gloomy Chinese outlook, persisting monetary headwinds, and the recent service sector weakness signs.

The disinflationary process is underway, but not enough for the ECB to be confident to the timely return to the 2% target.

The worsened economic outlook and markets turning more dovish, we expect the ECB to deliver a 25bp hike at the September meeting, marking a peak in the deposit rate of 4.00%