Just as European sentiment indicators were showing signs of improvement, confidence took a hit from the renewed escalation of the US-China trade war and potential US-Mexico tariffs. With external demand remaining a headwind, the longevity of the expansion will increasingly depend on developments in domestic demand. In that light it is reassuring that private consumption in Germany jumped by the most in eight years in Q1 and that May's service PMI remained in expansionary territory at 52.9. However, although activity in the services sector continues to hold up well overall, new incoming business and expectations eased, raising the risk that the manufacturing slowdown is spreading to the current engine of growth. Another risk relates to the labour market, where manufacturers have reportedly started to reduce staffing in light of weaker sales prospects and rising geopolitical uncertainty. All that leads us to conclude that the euro area will not be able to maintain its current growth pace of 0.4% q/q in the coming quarters, though we remain some way off recessionary territory (see growth tracker). We also updated our economic outlook, including a 2021 forecast, see Renewed Trade Dispute Casts Shadow Over Global Economy p12 , 10 June.
At the policy meeting last week, the ECB decided to extend the forward guidance to 'at present levels at least through H1 2020' as well as announce the liquidity operation details (TLTRO3). The updated staff projections were broadly unchanged, leading to an unchanged baseline narrative, although the external environment posed a more prominent risk than previously. In light of the increased risks, the ECB made clear that it is ready to act should it be needed. Therefore, we expect the ECB to step up its policy stimuli only if we see a deterioration beyond the already expected slowdown near term.
As fears about a cyclical downturn in the economy have intensified, market-based inflation expectations have continued to slide. As the Easter boost to travel-related service prices waned, core disappointed and fell back to 0.8% in May. We do not throw in the towel on our relatively upbeat inflation projections for this year, as we still wait for the details of the drivers for May's low print. Looking ahead, we continue to find reasons to expect core inflation to trend gradually upwards towards year-end, albeit we acknowledge downside risks to our inflation forecast as outlined in Inflation under the microscope: simmering, not boiling , 10 May.
Although the EU elections saw shrinking support for established parties in many countries, the influence of eurosceptic groups in terms of policy-making will remain limited with a vote share of 23%. Losses for the Social Democrats and Conservatives - which lost their absolute majority for the first time since 1979 - were amply offset by gains for the Greens and Liberals, meaning that overall sentiment in parliament will remain pro-EU. The focus in Brussels now reverts to choosing a successor for Jean-Claude Juncker as Commission president, but a vote is unlikely to take place before July and might well be delayed into the autumn. The nationality of the next EU Commission president is also important when it comes to the ECB presidency succession (see also Let the EU 'Game of Thrones' begin , 27 May).
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