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Euro zone heading for another downturn, warns ECB vice-president

Rapid pace of disinflation seen last year likely to ‘slow down’ in 2024

Mr de Guindos's comments underline how the ECB faces an awkward decision when it meets on January 25th over how early to start cutting rates. Photograph: Aris Oikonomou/Getty

Martin Arnold
Wed Jan 10 2024 - 14:25

The euro zone economy looks set for another downturn in the fourth quarter, while a recent pick up in inflation is expected to persist in the coming months, the vice-president of the European Central Bank (ECB) has warned.

In comments aimed at damping market expectations of an interest-rate cut in March, Luis de Guindos said in a speech in Madrid on Wednesday that the rapid pace of disinflation seen last year was likely to “slow down in 2024 and to pause temporarily at the beginning of the year” after price growth picked up from 2.4 per cent in November to 2.9 per cent in December.

He added that soft indicators pointed to an economic contraction in December. That would confirm “the possibility of a technical recession in the second half of 2023 and weak prospects for the near term”, he said.

His comments underline how the ECB faces an awkward decision when it meets on January 25th over how early to start cutting rates when the economic outlook is weak and inflation remains above the ECB’s target of 2 per cent. While many economists and investors predict euro zone inflation will hit that target this year, the central bank is not forecasting this until the third quarter of 2025.

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Mr De Guindos did not say what a likely recession would mean for monetary policy – sticking to the ECB’s oft-repeated line that “future decisions will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction”.

Carsten Brzeski, an economist at Dutch bank ING, said the central banker’s comments about inflation picking up reduced the likelihood of a rate cut by the ECB in the first quarter. “If you connect the dots, it is another argument against March rate cut expectations,” he said.

Mr De Guindos said he expected inflation in the euro zone to follow a similar path to Spain, where it dropped below 2 per cent in June 2023 before rising above 3 per cent in the final four months of last year as the government phased out energy subsidies.

“Positive energy base effects will kick in and energy-related compensatory measures are set to expire, leading to a transitory pickup in inflation,” he said.

The euro zone economy stagnated for much of last year and shrank 0.1 per cent in the three months to September from the previous quarter.

It is widely expected to stage a mild recovery this year thanks to lower inflation and higher wages. The ECB had forecast last month that euro zone growth would accelerate from 0.1 per cent in the fourth quarter of 2023 to 0.4 per cent in the third quarter of this year.

But Mr De Guindos cast doubt on this by saying growth was “disappointing” and “the slowdown in activity appears to be broad-based, with construction and manufacturing being particularly affected”. He added: “Services are also set to soften in the coming months as a result of weaker activity in the rest of the economy.”

His gloomy outlook stems largely from a closely watched survey of euro zone purchasing managers that pointed to a continued decline of business activity at the end of last year. The S&P Global PMI index was revised up last week but that left it unchanged at 47.6, remaining well below the 50-mark that separates contraction from expansion.

The ECB last month pushed back against investor expectations of imminent rate cuts last month, saying it wanted to see signs of wage pressures cooling to be sure inflation would continue declining.

Mr De Guindos said the euro zone labour market “continues to be particularly resilient to the current slowdown” after unemployment in the bloc returned to a record low of 6.4 per cent in November.

But he added there were “the first signs of a correction” in the labour market after total hours worked fell slightly in the third quarter and job vacancies continued to decline. – Copyright The Financial Times Limited 2024

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