Eurozone Economic Headache Grows after Factory Orders Slide at Fastest Pace for Six Years 

© Christian Müller, Adobe Stock

- Eurozone industrial downturn extends into 2019, IHS data shows.

- As German factories, French economy, hit the rocks in January.

- Bloc's woes could push European Central Bank back into crisis mode.

The Eurozone economic outlook darkened Thursday after IHS PMI data revealed that new orders from the bloc's factories fell at their fastest pace for nearly six years in January, stoking an earlier headache that was already threatening the growth and European Central Bank (ECB) interest rate outlook. 

Manufacturing businesses reported their weakest rise in output for five-and-a-half years in January while new orders fell for their first time in over four years, declininig at a pace not seen since the middle of 2013.

"Company concerns centred on the overall bleaker economic picture developing for the year ahead, often linked to international trade tensions, Brexit and rising political stress, especially in France and Italy but also globally. The weakness of the auto sector also remained a key area of concern," IHS Markit says. 

The Eurozone manufacturing PMI fell to 50.5 in January, down from 51.4 in December, when markets had looked for a small increase to 51.5. The services PMI fell to 50.8, down from 51.2 when consensus was for an increase to 51.5. 

Declines in manufacturing were led by the industrial powerhouse that is the German factory sector. The German economy contracted by -0.2% in the third quarter, led by a decline in industrial output, but official data has since shown factory production falling in both October and November.

"The persistent slowdown in German manufacturing is a red flag. The Eurozone economy needs solid growth in its core manufacturing sector to perform at its best, and at the moment, it seems like growth here is falling off a cliff, almost that is," says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics.

German GDP data for the final quarter will be released on February 14 although economists have been saying a pick up in domestic activity, particularly in the services sector, is expected to see the economy spared from a recession

Protests and general economic weakness in France appear responsible for the bulk of the January downturn in the services sector as well as the deterioration in the broader Eurozone outlook. French GDP data for the final quarter will be released next week.

"France is still under the spell of the yellow vests: The real drag to the falling Eurozone PMIs was not Germany, though, but France (and the rest of the Eurozone). Activity in France failed to rebound and instead headed further south from 48.7 in December to 47.9 this month – well in the contraction territory," says Florion Hense, an economist at Germany's Berenberg Bank. 

PMI surveys measure changes in industry activity by asking respondents to rate conditions for employment, production, new orders, prices, deliveries and inventories. A number above the 50.0 level indicates industry expansion while a number below is consistent with contraction.

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"Trade War" Still a Threat to Eurozone

Markets care about PMI data because it is an important indicator of momentum within the economy. And economic growth has direct bearing on consumer price pressures, which dictate where interest rates will go next.

"While the 'yellow vests' may have been an important driver here, the question is whether this is not also reflecting the global slowdown. In Germany, manufacturing did not get the bounce back that was eagerly awaited either," counters Bert Colijn, an economist at ING Group in Germany.

President Donald Trump's so-called trade war with China has hurt the world's second largest economy, leading growth and industrial production to fall steeply in 2018, which has in turn hurt demand for components and products made in German factories. 

Negoatiators from both sides are in talks aimed at reaching a deal to end the tariff fight between the world's two largest economies before March 01, the date when tariffs on more than $200 billion of Chinese goods exported to the U.S. each year will more than double to 25%. 

The White House wants to end China's "unfair trade practices" and has threatened to clobber the nation with tariffs on all of its $567 billion annual exports to the U.S. if the country does not fall into line.

The global economy is expected to weaken more than it already did in 2018 if the trade war escalates. Given its large factory sector ,ingrained structural economic weaknesses and already-fragile outlook, the Eurozone will be right in the firing line of a worldwide downturn.  

"The downside risks to the economic outlook have increased further. The current weakness may last longer and become more entrenched. ECB President Draghi will acknowledge this in his press conference after the Governing Council meeting today, without announcing a policy shift though," says Hense. 

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ECB Interest Rate Outlook Under Spotlight

Thursday's data came ahead of January's European Central Bank interest rate meeting and with the market on edge over what President Mario Draghi & Co might have said.

Markets have been briefed repeatedly to expect an initial interest rate rise "once through the summer of 2019". However, that guidance always assumed the inflation outlook would remain consistent with a sustainable return toward the target of "close to but below 2%".  

And now, with economic growth slowing rapidly and the outlook apparently turning ever darker, analysts and economists are sceptical of whether economic activity will be sufficient enough to keep Eurozone inflation pressures alive.

"With underlying inflation a long way short of its close-to-2% target, the ECB is unlikely to raise policy rates at all this year or next, and will thus miss out entirely on the global tightening cycle. This would leave the ECB looking similar to the Bank of Japan," writes Andrew Kenningham, chief Eurozone economist at Capital Economics, in a January note to clients.

The ECB cited the China slowdown and uncertainty over Brexit as being behind a "changing balance of risks" that is now tilted firmly to the downside, although the bank says the threat of a Eurozone recession is "low".

Draghi hinted Thursday that the 2019 interest rate rise floated last year may now not happen until 2020, and warned markets that it stands ready to "adjust all instruments" if necessary, suggesting it is open to providing the economy with fresh monetary stimulus.

Thursday's events come less than a month after the ECB declared partial victory in its fight against below-target inflation and ended the quantitative easing programme that had seen it buying European bonds in order to force down market borrowing costs and stoke the growth required for inflation to rise.

The ECB has a history of being too slow to respond to changes in the outlook for inflation and the economy, even if uncertainty about a resolution to the trade war and Brexit do mean patience could be in order this time around.

In 2008 and 2009, after the financial crisis, the Bank of England and Federal Reserve cut their interest rates to record lows of 0.5% and 0.25% respectively and began quantitative easing. 

But the ECB's rate did not reach parity with either of these levels until 2013, and it didn't start quantitative easing until 2015, despite the inflation picture at the time being very similar to the current one.

Europe's central bank also has form for getting ahead of itself and jumping the proverbial shark. This is because after having cut its interest rate to a then-record low of 1% in 2009 to mitigate the effect of the crisis, it then raised rates on two oaccsions, taking the benchmark borrowing cost up to 1.5% in July 2011.

That second interest rate rise came just months before the Eurozone debt crisis reached a crescendo and threatened the very survival of the economic bloc and currency union. The ECB was subsequently forced into a retreat that took its interest rate down to zero, and other rates into negative territory. 

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