Brace yourself for the recession

It was hard to swallow when Germany had to report its first trade deficit in more than thirty years. As well as the sharp decline in consumer confidence and the increasing tightness in the energy market, it is a sign that Europe is entering a difficult economic period.

Even the European Central Bank (ECB) is moving with the times. But anyone who thinks of a major change of course will be disappointed. The policy choices are announced at meetings half an hour later: a quarter past two instead of a quarter to two. For the next meeting on 21 July, this choice will not come as a surprise. Chairman Christine Lagarde has already announced well in advance that an interest rate increase of a quarter percent is imminent. The big question is what will happen next. Looking back at last week's first half, it seemed for a while that the bank could surprise in the coming months with more and larger rate hikes than the markets are anticipating.

Ominous signal
In recent days, however, there have been more and more signals that the reverse scenario must also be taken into account. A very ominous signal was that the German trade balance plunged into the red. The total import value of goods and services exceeded the export value by €1 billion in May. This was mainly due to higher prices for energy and food imports. As a result, the total value of all imported goods and services increased by more than a quarter. The total export value grew by almost 12%. It has been a long time since the trade balance turned out negatively for export champion Germany. The previous deficit dates from 1991: just after the reunification of East and West Germany.

Economic decline
The sharp fall in consumer confidence is another indication that the European economy is heading for a period of economic contraction. In just a few months, this eurozone indicator has fallen from -11 to -24. This indicates that the economic picture of European consumers is almost as pessimistic as during the corona panic in the spring of 2020. Is that fear justified? There is a good chance that meteorologists can answer that question sooner than economists. The natural gas reserves in Western Europe are very moderately filled. If we go through a cold winter, it has major consequences. In order to prevent reserves from becoming exhausted, politicians will then give priority to households over industry in the energy supply.

We are warm
It is a nice prospect that the European population is warm even in that scenario. But if, for example, the manufacturing industry has to cease activity three days a week during peak hours, that will have a hard economic impact. The German car manufacturers – together accounting for 10% of the economy – will then not be able to produce nearly enough to maintain the level of exports. The ECB then has little choice but to shift its focus from fighting inflation to saving the European economy. If the expected interest rate hikes fail to materialize, the euro will come under even more pressure. It is far from that yet. But even in this scenario, the European currency could become one of the big surprises in the second half of 2022.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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