Europe’s latest economic indicators paint an increasingly black picture for the eurozone outlook, as data released on August 24 indicates a continued weakening of activity and suggests a recession in the second half of this year, Oxford Economics said in a note.

“Economic indicators released this week suggest activity in the eurozone continues to weaken. The August eurozone PMI fell to the lowest level in three years, with Germany once again faring the worst among European economies,” Oxford Economics said. “With no real activity data yet available for the third quarter, we are still reliant on surveys to gauge the extent of the slowdown. But with the deterioration in activity broadening from the industrial sector into services, the likelihood that the economy will fall into recession in the second half is increasing.”

The sharp deterioration in growth data has persuaded analysts to revise their outlook for interest rates hikes by the European Central Bank (ECB), which is now expected to end its tightening cycle and leave rates on hold at the September meeting.

The August Purchasing Managers' Index (PMI) for the eurozone has fallen to its lowest level in three years. Within the EU, Germany's economy stands out as particularly hard-hit among European nations.

The downturn is not limited to a specific sector; the decline in activity is spreading from the industrial realm to the services sector, says Oxford Economics.

Europe is suffering from the impact of a polycrisis  that started with the pandemic in 2020 and was followed by the war in Ukraine and the boomerang effects of sanctions on Russia that has sent energy prices through the roof and fuelled strong and persistent inflation that has crushed growth.

While Europe’s gas storage tanks are over 90% full well before the mandatory deadline in November, that doesn’t guarantee supplies of gas in Europe will be sufficient to get through the heating season without prices rising again as Russia’s exports of gas that provide the base supply have fallen from 150bcm a year to 25bcm expected this year.

In 2022 the shortfall was made by record imports of LNG up from 80bcm in 2021 to 130bcm in 2022, but supplies of LNG are limited and Europe has to compete with Asia, so much depends on both the weather and China’s economic performance.

In the meantime gas prices have already risen from $350 per thousand cubic metres in July to over $500 in August as traders begin to anticipate a shortfall.

While prices have fallen from records set last year that were ten-times higher than normal, they remain 2-3 times higher than the long-run average prices and that has led to a steady deindustrialisation  in Europe where energy intensive and gas-reliant industry close down, as they are no longer economically viable, which is contributing to the slowdown. The ECB is likely to try and support growth by holding rates steady at its next meeting.

“While the upcoming decision by the European Central Bank (ECB) at their September meeting remains uncertain, the balance between growth and inflation risks has changed enough for us to predict a pause in the ECB's hiking cycle,” Oxford Economics said in a note.

Interestingly, the PMI figures contrast with some sentiment data released earlier, such as the ZEW and Sentix indices. While these indices hinted at improvement, but Oxford Economics expressed caution until corroborating data emerged.

“Regrettably, the disappointing PMI figures have confirmed our scepticism. Further underscoring the gloom, consumer confidence data released later in the week reflects a pessimistic sentiment despite record employment figures,” Oxford Economics said.

The August PMI report provides little to inspire optimism, with price measures showing signs of reacceleration even as activity falters. Notably, the weakening trend isn't confined to manufacturing but has extended its reach into the services sector, which had been bolstering growth in recent quarters.

“A significant drop in the services sector would almost certainly lead to GDP contraction,” Oxford Economics says. “Our current projections anticipate a modest 0.1% expansion for the eurozone economy in both the third quarter and the fourth quarter, but these numbers are likely to be revised downward in our upcoming update.”