Europe: It’s just one of those days

The Q3 honeymoon is over: There was nothing to cheer us up in the European session this morning. The PMIs confirmed that the euro area’s economy recovery stalled this month. The euro area flash manufacturing PMI rose by 2 points to 53.7, thus continuing to recover, but the services index slumped in contraction again by 2.9 points to 47.6 vs expected 50.5 and prior 50.5. France’s economic situation is especially worrying. The flash services PMI was a big miss, falling to 48.5 vs expected 51.5 and prior 51.5. This is the first contraction in private sector business activity since May. On top of it, the GfK consumer confidence index for October for Germany was released. It stalled at -1.6, well below the pre-COVID trend. All these statistics indicate rising contagion fears and renewed pressure on the services sector and notably the most COVID-19 sensitive sectors, namely recreation and culture services, restaurants and hotels and transportation.

Divergent “K”-shaped recovery between the manufacturing and the services sectors: As mentioned yesterday in our Monthly Macro Update (see here), we can all agree that we are facing a “K’-shaped recovery, which is well shown by today’s data. It means we will see a growing decoupling of economic growth in coming months between countries, sectors and companies. This divergence is already visible between the manufacturing and the services sectors, especially in Germany. The September flash manufacturing PMI is out today at 56.6, the highest level since Summer 2018, while the flash services PMI is back in contraction at 49.1. The explanation behind this gap is the manufacturing sector is finally benefiting from a return in foreign demand, with strong new orders, while activity in the services sector is pushed down again by the resurgence of new COVID-cases and the implementation of further restrictions. The contrast is also striking in employment conditions with further job losses in the services sector but an easing in manufacturing job cuts. It is of prime importance to understand that the PMIs cover a period before most of the new social distancing measures were implemented. In other words, more downside in activity in the service sector is likely in the coming months.

The “divided Europe” theme is back on the radar again: Due to a more severe impact of the pandemic and higher economic dependence on the most sensitive sectors to the COVID-19, such as tourism, the recovery is lagging in Southern Europe. The strong acceleration in the pace of services activity contraction and job losses in the periphery reinforces fears that Europe will face a two-speed recovery. If this scenario happens, it is only a matter of time before Europe will need to discuss additional transfers to the South that would top transfers already agreed as part of the NextGenerationEU stimulus package. If we take the example of Spain, which is certainly the most economically vulnerable country in Southern Europe, net transfers will represent only EUR82bn with most of the disbursement happening in 2023-24. This is too little and too late to cope with the depth of the crisis.

Europe is in danger of facing a relapse of the crisis in Q4: Today’s statistics constitute a very worrying signal for policymakers, both governments and the ECB, and an incentive to do more to support economic conditions. While it is very difficult to draw conclusions from the absolute PMI levels due to data noise, it is bright clear that the large and targeted fiscal response along with very accommodative monetary policy have not been able to put the recovery on solid path. Given the steady upward trend in COVID-19 cases, deaths and net admissions to intensive care in most European countries, there is no doubt that we are already dealing with the second wave of the pandemic. Governments are better-prepared so we can hopefully expect the number of deaths and acute cases will remain under control and will not reach levels seen in March. But we realize on a daily basis that it is extremely complicated to live with the virus and we won’t avoid further restrictions to mobility in the coming weeks that will increase economic disruptions and fragilize the recovery. The September flash PMIs support our view that we are in danger of facing a relapse of the crisis in Q4 due to the combination of COVID-19 and the seasonal flu, that will dampen consumption and investment, and thus encourage policymakers to resort to further stimulus. In this regard, it is now a done-deal that the ECB will increase its PEPP envelope by year end.