The Europeans see their German industrial-driven export model stuttering. The latest data, at least, shows that not only growth but also inflation is tanking, which raises hopes for the ECB to come to the rescue after having stomped out all post-pandemic enthusiasm with higher interest rates. 

Eurozone: Lower inflation calls for more ECB rate cuts

In August, German and Spanish consumer price index data surprised to the downside, suggesting that inflation pressures in the eurozone are continuing to ease at a faster pace than previously expected. The weaker inflation dynamics in Germany and the eurozone appear to be driven by persistently softer demand, which is making price increases increasingly difficult and has a growing negative impact on labour market dynamics.

This mix of weak growth and lower inflation gives the ECB ample room to ease its monetary policy. With our confidence in a further policy rate cut in September increased, we have adjusted our interest rate projection by adding a third cut for this year, and now expect a policy rate cut at each of the three remaining ECB meetings.

Europe: Industrial activity remains sluggish

The European economy, particularly Germany, is grappling with industrial weakness alongside a slowdown in growth. The eurozone manufacturing PMI has been in contractionary territory since July 2022, pointing to a continued decline in industrial production. Ultimately rooted in globalisation driven by relocation of manufacturing to regions with lower costs, the pandemic and rising energy prices accelerated the deindustrialisation trend in Europe, hitting hardest the energy-intensive industries, which struggled to remain competitive amid rising costs and supply chain disruptions.

The ECB’s interest rate hikes, while successful in curbing inflation, have led to higher borrowing costs, impacting households and corporate borrowers alike. In Germany, the EU’s largest exporter and importer, high interest rates have led to a significant increase in corporate insolvencies.

This trend highlights the ongoing structural challenges within the German economy and its industrial sector. Overall economic growth in Germany remains weak, also largely due to high interest rates, which have discouraged investment and dampened private consumption. The high savings rate among consumers reflects both weak consumer sentiment and the attractiveness of saving in a high interest rate environment. 

In addition to economic factors, bureaucratic inefficiencies and political uncertainties further complicate the resolution of these challenges. These arguments add to calls to reduce interest rates sooner rather than later.

Switzerland: Economy defies a difficult environment

Economic indicators for August are pointing to improving Swiss economic activity. The Swiss economy appears to be doing better than expected, according to the latest economic indicators. This is a positive surprise, particularly given the ongoing struggles of the manufacturing sector in the eurozone and the appreciation of the Swiss franc in August, which weighs on Swiss export competitiveness. However, it remains to be seen whether the Swiss industry will in fact be able to recover in this environment.

At the same time, the services sector moved back into expansion after a dip in July and the KOF economic barometer, another leading indicator for the Swiss economy, also picked up in August, signalling a slight recovery. 

While the latest positive surprises in Swiss economic data may alleviate some of the Swiss National Bank’s (SNB) growth concerns, we do not believe that they will materially change its economic assessment. With inflation currently at 1.3% in June and July, and possibly lower in August, it is still well within the SNB’s target range and we expect a final 25% rate cut on 26 September.

What does this mean for investors?

On a broader scale, both the equally weighted S&P 500 Index and developed market equities outside the US are trading at all-time highs. Therefore, it is likely just a matter of time before the S&P 500 reaches new all-time highs.

Just as impressive is the performance of US high-yield bonds, which have risen to new all-time highs and have experienced only one down week in the past 14 weeks. Even though September is traditionally a scary month for equities and US high-yield bonds, this year’s short-term buying spree may indicate broad demand that cannot be ignored. We recommend investors to remain invested and not be deterred.

While the eurozone faces its problems, we don’t see a dead end. This means tweaking a few positions here and there rather than targeting big shifts.