Euro Area Has a Budding Feel-Good Story If ECB Wants to Wait

(Bloomberg) -- Want the lowdown on European markets? In your inbox before the open, every day. Sign up here.

Scratch below the surface of the euro area's dismal economic numbers and there's a glimmer of hope that things could improve.

While inflation remains in hibernation and factories are seeing orders drop, companies are continuing to hire and consumers are spending more from their rising wages. That's why European Central Bank officials are showing a reluctance to race into action in response to the slowdown sweeping across the region.

Policy makers have long clung to domestic demand as a hope for the economy amid a weaker global backdrop. They'll have to decide at their meeting in Frankfurt on Thursday whether it's still strong enough to sustain growth or if fresh support may be needed.

“Not only is there hope of a cyclical improvement with the consumer still in a healthy shape and external headwinds fading, but this should remain the ECB's baseline,” said Frederik Ducrozet, global strategist at Banque Pictet in Geneva. “There is no alternative for them in order to move forward with policy normalization, however gradual.”

Updated economic forecasts through 2021 will be crucial to the Governing Council's assessment. While many officials have flagged sweeping cuts to this year's projections, they have been less vocal about the medium-term outlook that guides policy decisions.

The lowest unemployment in more than a decade has propped up households' confidence in personal finances. In France, where the mood soured late last year during disruptive public protests, sentiment has rebounded. Firms are increasingly hiring workers on permanent contracts, and consumer spending rose the most in almost a year.

Also on the plus side: German companies are showing tentative signs of improvement after suffering collateral damage from the U.S.-China trade spat. Manufacturers' export expectations -- a gauge for future investment -- improved for the first time in five months. A credible trade deal could cement fledgling signs of optimism, as could clarity on the U.K.'s Brexit plans.

Credit growth tells a more cautious tale, with loans to companies having seen slower increases since the middle of last year.

Developments in Italy, where the economy is already in recession, are troubling. A sentiment index based on Twitter posts has taken a dramatic turn lower and manufacturing orders are plunging.

Yet the key source of concern for the ECB is persistently weak inflation. The rate measuring the underlying trend has taken an unexpected dip and factories reported easing price pressures.

The ECB's official line has been that a stronger labor market and improving wage growth are a testament to the general health of the euro-area economy that will lead to higher inflation eventually. German states agreed to raise public-sector pay by about 8 percent over the next couple of years.

“The market's focus should be entirely on the ECB's 2020 forecasts,” said Marchel Alexandrovich, senior European economist at Jefferies. “As long as these stay broadly unchanged, it should send a clear signal that the ECB has not fundamentally changed its view that policy normalization remains on the agenda -- even if the timeline has shifted by a quarter or two.”

To contact the reporter on this story: Piotr Skolimowski in Frankfurt at pskolimowski@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Jana Randow

©2019 Bloomberg L.P.