Euro Zone Recovery Led by Germany and France as ECB Rate Cuts Expected

Key Takeaway

• German PMI rose to 52.2 in May, indicating the fastest private-sector growth in a year, driven by services.
• DAX Q1 earnings fell 12% YoY but financials and tech sectors showed strong performance; potential ECB rate cuts could boost stocks.
• Euro zone recovery led by Germany and France; ECB rate cuts expected as inflation retreats toward 2%.

German Economic Momentum

The German economy is showing signs of recovery, as indicated by recent Purchasing Managers' Index (PMI) data. S&P Global's PMI for Germany rose to 52.2 in May, surpassing analyst expectations and remaining above the 50 threshold that signals growth for the second consecutive month. This marks the fastest pace of private-sector activity growth in a year. The services sector continued to lead the advance, while the manufacturing sector, although still in contraction territory, recorded its highest reading since January.

Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, noted signs of a potential turnaround in the manufacturing sector. "These numbers offer hope," he said. "Those predicting a prolonged weakness in the German economy might be proven wrong soon." Additionally, businesses in Germany raised output prices at the slowest pace since early 2021, reflecting a cooling of input cost inflation. This development is particularly noteworthy as it aligns with the European Central Bank's (ECB) objectives, potentially paving the way for interest rate cuts.

Euro Zone Economic Outlook

The euro zone's two largest economies, Germany and France, expanded more than expected in the first quarter of 2024, helping to pull the 20-nation bloc out of the recession experienced in the latter half of last year. Analysts expect reductions in interest rates by the ECB to support a recovery across the region later this year, with inflation retreating toward 2% after its historic spike.

However, the economic outlook in France was less positive, with the composite gauge unexpectedly dipping back below 50, dragged down by the services sector. Despite this, Norman Liebke, an economist at Hamburg Commercial Bank, expressed optimism about France's economic prospects. "Demand has grown for the first time in over a year and employment is still growing robustly," he said. "France’s manufacturing sector is slowly making a comeback." Both the Bundesbank and the Bank of France predict slight growth in gross domestic product (GDP) in the second quarter, with Hamburg Commercial Bank suggesting an expansion of 0.3% for each country this quarter.

German Stocks and Earnings

German stocks are expected to benefit from the improving economic backdrop, despite some headwinds. According to Deutsche Bank data, DAX first-quarter earnings fell by 12% year-over-year, mainly due to declines in industrials and autos. However, the earnings season also saw strong performances in various industries and positive outlooks. Financials were the biggest positive earnings driver, with Commerzbank upgrading its lending income outlook. Chipmaker Infineon reported positive developments in China and Europe's electric vehicle markets, while Siemens Energy saw a rally due to a turnaround in its wind unit and job cuts.

The improving economic outlook and potential ECB interest rate cuts are expected to boost German stocks further. Investor confidence in Germany has risen, and the services sector is showing signs of improvement, although manufacturing remains soft. Recovery in the Chinese economy is also expected to provide support. Consensus forecasts suggest the DAX could achieve double-digit profit growth in the second half of 2024, with Deutsche Bank projecting 5% earnings growth for both the DAX and Stoxx 600 in 2024.

Street Views

• Cyrus de la Rubia, Hamburg Commercial Bank (Cautiously Optimistic on the German economy):

  "These numbers offer hope. Those predicting a prolonged weakness in the German economy might be proven wrong soon."

• Norman Liebke, Hamburg Commercial Bank (Neutral on France's economic outlook):

  "Demand has grown for the first time in over a year and employment is still growing robustly. France’s manufacturing sector is slowly making a comeback."