Europe is slowing down significantly. What will the European Central Bank do?

This week all eyes will be on Thursday's ECB meeting. While mild temperatures this fall suggest a dramatic gas crisis may be avoided, Monday's purchasing managers' indices for the euro zone show that the economy is headed for recession.

Economic growth forecasts

Probably today's Ifo index will signal the same today. It appears that The ECB will have to revise its economic growth forecasts downwards. Members of the European institution signaled that the recession should not stop the central bank from continuing the normalization process. In view of very high inflation rates, more decisive action would be necessary, otherwise there is a risk that inflation expectations will be anchored at a high level. In the case of too undecided approach, there is a risk that a tighter monetary policy tightening will be necessary later. Therefore, the market expects a “hawkish” decision next Thursday. There will probably be another increase in interest rates by 75 basis points.

Additionally, the conditions of the TLTRO program will be changed. In recent times, almost half of European decision-makers have clearly or indirectly signaled their support for such a big step. The statements of the Council members show that the neutral interest rate - i.e. the one that neither slows down nor stimulates the economy - is currently seen by the Council at 2%, i.e. clearly higher than in the first half of the year, so another strong upward move seems to be more necessary than before. While earlier dovish and hawks in the ECB discussed whether monetary policy should be tightened above the neutral level, now it seems that they are more focused on how much the deposit rate should be raised above this level.

Loss of purchasing power

Yesterday we received another confirmation that the euro area economy is in a bad shape. The index of purchasing managers in the services sector - the most reliable economic barometer for this area - fell to 48,2 points in October. In turn, the index for the manufacturing sector declined by 1,8 points to 46,6 points. The last time the PMI for services was so low was in February 2021, when the pandemic caused a temporary collapse of the European economy. The continual loss of purchasing power due to high inflation is taking an ever deeper mark on private consumption. The service sector in particular is feeling it full force. Activity in this sector appears to be slowing down further.

The situation in the manufacturing industry is even more critical. Not only is it suffering from weaker demand from private households. Huge increases in electricity and gas prices make the production of some goods unprofitable, and therefore companies limit production despite having enough orders. At the same time, uncertainty about future natural gas supplies makes companies more cautious, which argues for less investment. Yesterday's readings increase the probability that in the last quarter of this year the euro zone economy will shrink significantly.

EUR / USD is in an interesting place considering the technical analysis. The rate borders on the resistance, which is the upper limit of the downward channel. Its break may lead to parity, which was tested in the first days of October. The dollar will not receive support from Fed representatives in the coming days, as we are in the blackout period, so I see a better chance of continuing to trade northwards.

Source: Łukasz Zembik, OANDA TMS Brokers