ZEW Current Conditions & Economic Sentiment what do they mean?

The ECB Rate Cut and Its Implications for the German Economy: Key Focus on the ZEW Economic Sentiment

Last week, the European Central Bank (ECB) made a significant move to cut interest rates for the second time this year, after the first cut was initiated in the June meeting.  The decision to lower the Benchmark interest rate to 3.50% as well as the Deposit Facility Rate (Sep) rate by 25 basis points to 3.50% came due to policymakers agreeing that persistent inflation had cooled off enough to lower rates further but also the now increasing concerns of an increased risk of a recession if rates were held at the previous level.

The ECB’s drastic rate increases that started 2 years ago now need to be unwound carefully to not cause any long-lasting issues. And this is exactly what the ECB had planned, by cutting interest rates in 25 bp increments, it could show the ECB if there are sticky inflationary risks that could be muffled with leaving the rates at a satisfactory level for longer once more data is available.

By avoiding cutting too much too soon, the ECB is avoiding the risk of any comeback in inflation but shows the attempt to put out their feelers and test how the market could react. Especially now that most economic indicators have fallen to satisfactory levels that show that the required economic slowdown has been achieved.

This is most dominant in the decrease in business and as consumers grapple with tight financial conditions as well as elevated costs.

This makes the German ZEW Economic Sentiment and Current Conditions Index, which will be released on September 17, 2024 even more important, as this report will provide further insights into how Germany’s business leaders and investors perceive the current economic landscape, especially now after the ECB’s rate decision. With Germany being Europe’s biggest economy, this is of high importance.

ECB Rate Cut: A Response to Slowing Growth and Inflationary Pressures

The central bank’s focus has now turned towards easing economic growth and cause a soft landing for the economy. According to Lagarde, the dynamic stands that underlying headline inflation will be around 2.5% in the year 2024, 2.2% in 2025, and 1.9% in 2026. However, inflation is expected to rise again in this year, because previous sharp drops in energy prices will drop out of the rates. But it should then decline to the target in the second half of next year.

Core inflation had been revised slightly higher to 2.9% in this year, to 2.3% in 2025 and 2.0% in 2026.

Domestic inflation remains at a high level, as wages are still rising at an above-average rate, labour costs are weakening and profits are cushioning the impact of inflation.

The financing remains restricted reflecting weak private consumption and investment.

It is also projected by the ECB that the economy will grow by 0.8% in 2024 rising to 1.3% in 2025 and 1.5% in 2026. This is slightly lower than the June projections, owing mainly to the weaker demand in the domestic market.

Overall Inflation, while still high, has started to moderate, giving the ECB room to adjust its stance.

For Germany, in particular, the ECB’s decision could have the biggest impact on its industrial sector, which has been hit by slowing demand, rising energy costs, and global supply chain disruptions.

So why is the ZEW Economic Sentiment and Current Conditions important?

Because on September 17, the ZEW Current Conditions and Economic Sentiment Index will provide give insights into how the market perceives the current and future state of the German economy. As the ZEW survey polls around 300 analysts and institutional investors to gauge their expectations for the economy over the next six months. Following the ECB’s rate cut, these indicators are now even more important than before, which is constructed of 2 parts. The Current conditions index and the Economic sentiment index. Let me explain.

• Current Conditions Index: This measures the current health of the German economy. In the past 2 years, it has shown a negative value, potentially being attributed to the effects of interest rate hikes and the cross play between the challenges faced in the manufacturing sector. With industrial production down and new orders declining, the September report could reveal whether business leaders feel the situation is finally improving after the ECB’s rate cut. So if confidence in the current environment remains low, it could indicate that the rate cut may take longer to have a measurable impact.

• Economic Sentiment Index: This indicator is  forward-looking as it reflects expectations for economic activity in the coming months. In August, the index fell again to the lower levels of the recent year and showed the lingering pessimism about future growth prospects. Therefore, a bounce higher, could signal that the ECB’s rate cut is boosting confidence, and potentially leading to a more buoyant market. However, if the sentiment remains low, it may indicate that businesses and investors are still wary of various factors that affect them and therefore clouding the economic outlook.

How the ECB Rate Cut Could Affect the German Economy

The lower borrowing costs could stimulate investment, particularly in industries that are dependent on credit, such as construction and manufacturing. Consumer spending may pick up slightly as well due to lower interest rates on loans and mortgages. However, the immediate effect may be limited, as businesses are facing high energy prices and a lack of global demand for German exports. However with the last manufacturing orders data release having come out of negative territories, we might already be experiencing some return in this regard.

So what effect can we get from the German ZEW Economic Sentiment and Current Conditions?

If the ZEW Economic Sentiment Index shows an improvement to the previous releases, this could then fuel optimism for the consumers and the economy and push German markets higher. Conversely a continuing low number shows current pessimism and could muffle any potential upside in the market.

Risks from abroad remain

While the ECB’s rate cut could provide a short-term boost, there are still some risks to consider in the current environment that the EU does not influence.

The global economic slowdown that has particularly hit China and the United States, could continue to be detrimental to German exports, until these economies speed up at the same level.  Additionally, inflationary pressures, particularly in energy and food prices are high, which currently erode the purchasing power of consumers and businesses.

Conclusion

If the German ZEW indicators fail to show significant improvement in sentiment and outlook, it could signal that deeper structural issues within the economy require more than just monetary policy adjustments.

The ECB’s rate cut however, could show confidence in the development for the Eurozone economy, particularly for Germany, where industrial output has struggled. All eyes will now be on the German ZEW Economic Sentiment and Current Conditions Index, which will provide the key insights into how businesses and investors are responding to the new monetary environment. If confidence picks up, it could act as a catalyst for a more buoyant market, but if sentiment remains low, it may indicate that more substantial measures are needed to support growth.

With kind regards,

Philip P