Eurozone: No End to the Bad News

- Sentiment among Eurozone purchasing managers fell to a fresh record low in December. The 26% yoy plunge in new car registrations reported today for November also illustrates the depth of the recession.

We lower our forecast for 2009 GDP from -1.8% to -2.2%. Although many ECB council members still seem reluctant to cut rates again in January, we expect the ECB to notice soon that its most recent staff projections for 2009 GDP are far too rosy. A more realistic assessment of the current recession should pave the way for a 50bp rate cut on January 15.


Eurozone: No End to the Bad News

There is no end to the bad news. Sentiment among Eurozone purchasing managers fell further, to new record lows in December. The data point to an additional severe decline in GDP in early 2009. Although many ECB speakers have indicated over the last few days that they are reluctant to ease policy again in January, we find it difficult to believe that the ECB can just ignore the torrent of bad data. We expect the ECB to cut rates further by 50bp on January 15, to 2.0%.

The services PMI index for the Eurozone declined from 42.5 in November to 42.0 in December, by far the lowest level in the 10-year history of the series. The details reveal a drop in new business from 40.4 to 39.1 and a modest decline in hiring intentions from 47.9 to 47.3. In line with falling oil prices and weakening demand, inflationary pressures are declining, taking the readings for input prices down from 57.5 in October and 54.3 in November to 50.9 in December and for output prices from 50.4 in October to 47.1 in November and a mere 44.9 in December.

Interestingly, expectations recovered slightly from 41.6 in November to 42.4 in December. With luck, this may be a first sign that the overall index may hit bottom at some time in early 2009.


The bad news from the more inward-oriented service sector is in line with the continuing decline in the more export-oriented manufacturing sector. According to today’s flash estimate, the manufacturing PMI dropped from an extremely bad 35.6 in November to a new record low of 34.5 in December, led by declines in output (from 32.6 to 31.7) and employment (from 41.0 to 39.1). This takes the composite PMI down to a dismal 38.3 for December after a very bad 38.9 in November. It goes almost without saying that the December result is the worst in the 10-year history of the composite indicator as well.

Unfortunately, the purchasing managers’ index is the best leading indicator for the immediate future of the economy. The 4Q average reading of the composite PMI is compatible with a 2.6% yoy decline in Eurozone GDP in 1Q 2009 (see picture above). Taking the December level instead of the 4Q average would even point to 3.0% yoy decline for GDP in early 2009. Of course, the PMI flash estimates today came in slightly less bad than the consensus estimates had projected. However, we would not attach much weight to this. Over the last few months, the flash PMI results has usually been revised down noticeably in the subsequent final releases.

Other economic news are not more encouraging either, with the 26% yoy decline reported for Eurozone car registrations in November being just one further example. The available data suggest that, while consumer spending on non-durables is holding up ahead of Christmas thanks to rapidly receding inflation which raises the real purchasing power of consumers, spending by households on big-ticket durables such as cars is plunging almost like a stone. The same seems to hold for business investment as companies postpone investment projects amid mounting uncertainty about the economic outlook and tougher financing conditions imposed by banks.

In response to the bad data, we downgrade our forecast for 2009 Eurozone GDP growth further from -1.8% to -2.2%. The worst of the declines is likely to come around the current turn of the year, with GDP probably falling 1.1% qoq in 4Q 2008 and a further 0.9% in 1Q 2009. Even if GDP stabilizes in 3Q and starts to expand again in 4Q 2009, as we expect, the very low starting level for 2009 puts the average level of GDP next year 2.2% below the 2008 average in our forecast.

Many ECB speakers have indicated over the last few days that they are reluctant to continue with aggressive rate cuts, although some speakers such as Orphanides (Cyprus), Draghi (Italy), and Bonello (Malta) have sounded as if they are ready to move again in January. However, the recent economic data contradict the ECB staff projection of a mere 0.5% decline in 2009 GDP. In our view, these staff projections were very outdated when they were published on December 4. We expect the ECB debate on January 15 to be based on much less rosy internal projections. If so, this should pave the way for a follow-up rate cut from 2.5% to 2.0% in January.

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