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Euro Headwinds Amidst "a Worrying Signal for Germany's Economy"

German economy slows posing headwinds for the Euro

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The Euro faces headwinds to further advances amidst a notable slowdown in the Eurozone's largest economy and expectations for an unsupportive European Central Bank event on Thursday.

The ECB's October meeting concludes on Thursday and economists say policy makers will communicate the bloc's economy remains in need of generous monetary conditions; while supportive of the economic outlook such a stance is typically interpreted by strategists as a weight around the Euro.

Such an outcome from the ECB is all the more assured after Germany's most watched leading economic indicator - the Ifo business climate index - dropped for a fourth month in a row in October.

The Ifo read at 97.7, down from 98.9 points in September, a sign that the economy is entering a significant slowdown.

"The risk of the economy stagnating in the fourth quarter is high," says Carsten Brzeski Global Head of Macro at ING Bank. "The growth enthusiasm of the summer months has completely gone up in smoke."

The survey shows the Eurozone's largest economy is weighed down by supply problems and capacity utilisation in manufacturing is falling.

The Euro to Dollar exchange rate fell back 0.20% to 1.1624 at the head of the new week, placing a choker on the Euro's recent recovery.

The Pound to Euro exchange rate nudged higher to 1.1823 in response, allowing Sterling to arrest a recent decline against the single currency.

"Sand in the wheels of the German economy is hampering recovery," says Clemens Fuest, President of the ifo Institute.

Ifo disappoints

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"This is a worrying signal for Germany's economy," says Claus Vistesen, Chief Eurozone Economist at Pantheon Macroeconomics.

"The IFO expectations gauge is one of the best short-leading indicators we have in Germany, and it is currently pointing to a sharp near-term drop in momentum as the reopening bump fades," he adds.

The report is a widely observed early indicator for economic development in Germany and is based on ~9,000 monthly survey responses of firms in manufacturing, service sector, construction, wholesaling and retailing.

"A clear risk for the German economy would be a clear scaling down of new orders as a result of shortages," says Brzeski.

Like other global economies, Germany's faces ongoing supply chain frictions, surging gas prices and rising input inflation.

Brzeski says one upside to the souring outlook is the ingredients for a solid recovery remain; including richly-filled order books, low inventories in the manufacturing sector, a strong labour market and excess savings for consumers.

Pantheon Macroeconomics forecast Friday’s advance third quarter GDP data for Germany will show growth of 2.0% quarter-on-quarter, accelerating from a 1.6% increase in GDP in the second quarter, mainly due to a strength in services.

Their baseline for the fourth quarter is a 0.7% quarter-on-quarter increase.

But the Ifo indicator "is now warning us that this could be much too optimistic," says Vistesen.

Given the slowdown, the ECB will be keen to emphasise it will continue to offer supportive interest rates and generous quantitative easing settings.

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The ECB is anticipated to push back against the market's expectation that an interest rate rise could come as soon as late 2022 and maintain that 2024 is a more realistic target.

Expectations for an earlier rate rise is evident in money market pricing and reflects belief amongst investors that global central banks will react to surging global inflation by raising interest rates.

This reappraisal by markets will have offered the Euro some support of late and could explain why it has risen against the Dollar over recent weeks.

The Euro's resilience has meanwhile disappointed Pound Sterling bulls who would want to have seen a bigger push higher in GBP/EUR in the wake of an aggressive reappraisal of Bank of England rate hike intentions.

The ECB is anticipated by some economists to push back against this market repricing, threatening the Euro's recent robust nature.

"EUR may go under pressure as we expect the ECB to push back against more hawkish market expectation and maintain its very accommodative stance," says Marek Raczko, a strategist at

Barclays' FX strategists expect the ECB to talk down current market pricing, extinguishing any hope of narrowing rate differentials to support the euro higher.

They note money markets currently expect a rate rises of close to 10bp in a year and more than 30bp in two years.

"A largely status quo ECB stands in contrast with global central banks looking to normalise," says Raczko, "we expect the ECB to talk down current market pricing, extinguishing any hope of narrowing rate differentials to support the euro higher."

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