Eurozone consumer spending weak, European Central Bank may need to cut interest rates significantly to "stabilize the economy"

Eurozone consumer spending weakness has led analysts to believe that the economic recovery, which should have been driven by consumer spending, may not materialize. The Eurozone's strong performance in the first half of this year is now faltering. Manufacturing remains sluggish, household consumption has not picked up, and confidence is lower than pre-pandemic levels.

With inflation rates close to 2% at present, some officials at the European Central Bank see the struggling economy as another reason to push for a rate cut this week. If this weakness persists until 2025 and drags inflation below target, investors and analysts believe that the ECB may need to further loosen monetary policy.

Simon Wells, Chief European Economist at HSBC, said: "Recently, the lackluster economic growth seems to have become a more concerning issue for the ECB. Therefore, weak consumption may incline policymakers towards a more moderate direction."

On the surface, the elements for a consumption rebound are in place: inflation has fallen from a peak of 10.6% to 2.2%, unemployment is at a historic low, income growth outpaces price increases, and lower borrowing costs make mortgages cheaper. Martins Kazaks, ECB Governing Council member and Governor of the Bank of Latvia, said last week: "The most important thing is that inflation has indeed been significantly suppressed, and interest rates have started to decline. This is good news for the public as purchasing power is beginning to grow."

However, despite these factors, coupled with the boost from Germany hosting the European Football Championship and France hosting the Summer Olympics, consumer spending in the Eurozone remains weak. Eurostat reported last Friday that household consumption fell by 0.1% in the second quarter.

It was learned by Aito Finance that in Germany, the largest economy among the 20 Eurozone economies, consumer spending even declined during the same period, since then, due to layoffs and business bankruptcies, household confidence has declined. Volkswagen suffered another blow last week, with the company saying it may shut down a factory in the domestic market for the first time in its 87-year history.

Olaf Roik, Chief Economist at the German Retail Association, said: "We expect consumption to contribute to economic growth in Germany, but this has not yet happened. Our hope now lies in the second half of this year."

While the southern part of Europe has shown relatively better performance, it also faces unfavorable factors—especially countries like Italy and Spain have cut back on cost-of-living assistance. Coface economist Laurine Pividal said: "Households may anticipate that next year's fiscal policy will not be as favorable, and each economy must strive to reduce debt. With the depletion of government support programs, tax policies may affect households' expectations."

For the entire eurozone, consumption seems to be a weak link, posing a challenge to the European Central Bank's forecast of 0.9% GDP growth for the eurozone this year. In fact, data from last week showed that retail sales were lower than expected at the beginning of the third quarter, rising only by 0.1%. The latest consumer monthly survey by the European Central Bank stated: "Nominal spending expectations are at their lowest level since the outbreak of the Russia-Ukraine war in February 2022."

Policymakers at the European Central Bank discussed this issue at their last meeting in July. According to the meeting minutes, the strong growth in savings at the beginning of 2024 raised "questions about the consumption-based narrative in the forecasts," although the conclusion of the meeting was that the outlook remains on track.

However, analysts believe that when officials meet this week, the economic growth forecast for the eurozone this year will be revised downward, increasing the possibility of a rate cut in October, as investors have already fully priced in rate cuts in September and December.

Analysts at Bank of America stated that if economic output disappoints, it is likely that this measure will be considered, which is a "clear risk in the near term." They mentioned that a 50 basis point easing magnitude for the remainder of the year – equivalent to two 25 basis point standard rate cuts – is the "lower bound given the lack of a clear rebound in economic activity." Fitch Ratings, on the other hand, stated that subdued consumption is not surprising due to actual household incomes being below end-2019 levels.

Of course, some believe that such a recovery is on the horizon – just a bit later than hoped for. The German Central Bank stated in August that higher incomes should increasingly impact the continuously rising household spending. Economist Dorian Roucher from the French National Institute of Statistics and Economic Studies mentioned that consumers seem to be "gradually" taking into account the cooling of inflation, but their reaction to soaring prices is much quicker