On July 5, according to S&P Global data, the final Eurozone comprehensive PMI in June fell to 52 from 54.8 in May, a 16-month low; Chris Williamson, chief business economist of S&P Global Market Intelligence, said that the Eurozone Growth in business activity has deteriorated sha

The Paper News Reporter Hou Jiacheng

With the sharp decline in economic prosperity in the euro zone, market concerns about the euro zone economy falling into recession have pushed the euro-dollar exchange rate to a 20-year low.

html On July 5, according to S&P Global data, the final Eurozone comprehensive PMI value fell to 52 in June from 54.8 in May, a 16-month low; the final manufacturing PMI value fell to 52.1 from 54.6 in May; The final service PMI fell to 53 from 56.1 in May.

Euro zone PMI monthly trend, data source: Wind

On the same day, the euro-dollar exchange rate once fell to around 1.02, a new low since 2002, bringing it closer to parity with the U.S. dollar. According to Bloomberg data, as of press time, the euro-dollar exchange rate was 1.0185.

Euro-dollar exchange rate, data source: Wind

S&P Global Market Intelligence chief business economist Chris Williamson said that the sharp deterioration in the growth rate of business activity in the euro zone has increased the risk of the region falling into recession in the third quarter. The prosperity of the manufacturing industry has reached its lowest level in two years, while the service industry has obviously lost its growth momentum amid the cost of living crisis. Household spending on non-essential goods and services has been particularly pressured by soaring prices, while business spending and investment have also fallen amid a gloomier outlook and tighter fiscal conditions.

What does it mean that the euro exchange rate hits a 20-year low?

Hu Jie, a professor at Shanghai Advanced Institute of Finance at Shanghai Jiao Tong University, told The Paper that changes in the exchange rate of the euro against the U.S. dollar are mainly affected by two factors: interest rates and economic health.

The European and American economies were hit hard by the epidemic at the same time, but the U.S. economy recovered earlier than Europe. The United States' GDP rebounded strongly in Q3 of 2020, turning from negative growth to positive growth, while Europe only began to return to positive growth three quarters later in Q2 of 2021. Differences in the pace of economic recovery curbed the upward momentum of the euro against the dollar, with the exchange rate turning lower from January 2021.

In terms of the impact of interest rates, Hu Jie said that the United States began to raise interest rates in March 2022, which has been done three times so far, and the benchmark interest rate has entered the 1.50-1.75% range from 0.00-0.25%. The Eurozone only announced on June 9 that it would raise interest rates by 0.25% in July, bringing the benchmark interest rate to -0.25%. The differences in the steps and magnitude of interest rate hikes in Europe and the United States have further supported the decline of the euro against the dollar.

Cao Yubo, a researcher at the Financial Markets Department of the China Construction Bank Head Office, told The Paper that the euro experienced its largest one-day decline against the U.S. dollar in two years on July 5, mainly due to the sharp decline in the Eurozone service industry PMI announced that day, hitting a new low in more than a year. This may mean that the recovery of the euro zone's service industry is facing interruption and the economic outlook is bleak. Investors are increasingly worried about the euro zone economy falling into recession and are betting on the European Central Bank to slow down the process of raising interest rates, causing the euro to weaken against the US dollar, the Japanese yen and the Swiss Currencies with safe-haven attributes such as the franc have all experienced significant depreciation, which means that investors' risk aversion towards the economic prospects of the Eurozone has increased significantly.

Looking specifically at the bond yields in the Eurozone and the United States, Wang Jinbin, executive deputy secretary of the Party Committee, deputy dean and professor of the School of Economics at Renmin University of China, told The Paper that Europe's tightening monetary policy is not as tight and fast as the Federal Reserve , resulting in The gap between Eurozone bond yields and U.S. Treasury yields has widened.

"Even if there are expectations of interest rate hikes or interest rate hikes in Europe, bond yields cannot rise too high." Wang Jinbin also pointed out that Europe only has a unified currency but no unified finance; the tightening of monetary policy has a negative impact on different economies. There are significant asymmetries in shocks to government debt markets. The fiscal policy of the separation of the Eurozone determines that the cost of raising funds for economically unhealthy economies, such as Italy and Spain, will rise significantly. This may trigger a sovereign debt crisis, so the "ceiling" for rising European yields is relatively low.

What challenges does the Eurozone economy face now?

The economic sentiment in the Eurozone has been declining for many consecutive months. Cao Yubo said that one of the important sources of downward pressure on the euro zone economy is the energy shortage caused by the Russia-Ukraine conflict, especially the risk caused by the shortage of natural gas.European countries are highly dependent on Russia's energy imports. Since the Russia-Ukraine conflict, the rise in energy prices caused by supply shortages has had a significant impact on the European economy and has become the main reason for rising inflation in the euro zone.

Recently, according to media reports, the German government has prepared for the cutoff of natural gas supply, and the strike of oil and gas workers in Norway is still continuing.

"Germany is Europe's leading economy and an important industrial country. Once the supply of natural gas is cut off, the impact on the German economy will be immeasurable. The Eurozone economy may be in trouble, and the ECB's interest rate hike process may also face challenges." Cao Yubo said.

According to data from the German Federal Statistics Office, in euro terms, Germany's exports in May fell by 0.5% compared with April, and imports increased by 2.7%. The trade deficit was 1 billion euros, which was Germany's first since 1991 ( the reunification of the two Germanys Imports exceeded exports for the first time since 2002.

Germany's monthly trade balance , data source: Wind

Exports have been Germany's economic engine for years, but as Russia limits the amount of natural gas it can send to Europe, energy prices have risen sharply, pushing up the prices of German-made products.

Hu Jie pointed out that in May, German exports increased by 11.7% year-on-year, but imports increased by 27.8%. Over the past 70 years, Germany's import and export volumes have grown at an average annual growth rate of around 7.7%.

According to The New York Times , Volker Treier, director of foreign trade of the German Chamber of Commerce and Industry, said that exports have begun to decline and the cost of shipping German goods overseas continues to rise. Exporters will not be able to pass on increased costs in the supply chain to international customers.

Strained supply chains are expected to slow down the euro zone's largest economy, which relies heavily on exports, and could even lead to a recession. "Overall, we think the outlook is deteriorating sharply," Oxford Economics' Daniela Ordonez wrote in a report on the euro zone economy.

Wang Jinbin said that Europe's GDP growth in the first quarter exceeded expectations, and European countries experienced a single-month trade deficit since 1991, indicating that the European economy is recovering internally, and domestic demand, labor markets, and imports are relatively good; costs are rising, and Europe is dependent on external energy. The degree is too high, coupled with the downward pressure on the global economy, resulting in a trade deficit.

Inflation is high in the Eurozone. Why is the European Central Bank taking slow action to control inflation?

Under the influence of supply shortages caused by the Russia-Ukraine conflict, energy and food prices have soared, and the Eurozone CPI continues to hit new highs.

On July 1, local time, Eurostat data showed that the euro zone’s harmonized CPI in June increased by 8.6% year-on-year from the initial value, which was a further increase from 8.1% in May and was the highest level since statistical data were available in 1997.

Monthly inflation trend in the Eurozone, data source: Wind

Cao Yubo said that the inflation growth rate in the Eurozone has climbed to a historical high, and the increase in energy prices has contributed the most. From a breakdown point of view, most of the year-on-year growth rates of various types of fuel and energy prices in May exceeded 30%. Among them, the year-on-year growth rate of liquid fuels has reached more than 70%, which has also driven the growth in transportation, passenger transportation, industrial products and other related industries. The year-on-year growth rate of price levels is also higher than 10%. In comparison, the price growth rate of major service industries such as education, medical care, and communications is very slow. It can be seen that the rise in global energy prices is the main reason for the "high fever" of inflation in the Eurozone.

Wang Jinbin said that European inflation may not have peaked. Geographical conflicts have a greater impact on the Eurozone, leading to market expectations of continued higher inflation in the future, and at the same time exacerbating the long-term depreciation trend of the Euro.

The European Central Bank is expected to raise interest rates for the first time in more than a decade at its July meeting in an effort to curb the highest inflation since the birth of the euro in 1999. However, as the economic outlook for the euro zone dims, the market is worried that the European Central Bank will take action too late and has limited room to raise interest rates.

Hu Jie said that although the euro zone’s GDP growth rate in May was 2.7% year-on-year, which was within a healthy range, and the unemployment rate was 6.8%, the lowest level in 30 years, the cost of controlling high inflation will obviously suppress the good performance of these two indicators. At the same time, the world economy, represented by the U.S. economy, is facing similar problems, and a downward trend is inevitable.This will worsen the external environment of the Eurozone economy and pose a more serious challenge to it.

"Europe not only needs to deal with price increases, but also needs to adjust the supply chain structure. The side effects of raising interest rates on the economy will be more difficult, so it is more hesitant to take action." Hu Jie said that after repeated weighing, the European Central Bank finally announced in June that it would Interest rates were raised by 0.25% in July and may be raised by another 0.25% in September. At the same time, the European Central Bank also announced the end of quantitative easing, that is, the end of its monthly bond purchase operations of 15 billion to 80 billion euros since the European debt crisis. Previously, when European debt peaked in July 2012, the European Central Bank lowered its overnight deposit rate to 0.00%; it subsequently cut interest rates multiple times, lowering the interest rate to -0.50% in September 2019.

Wang Jinbin said that the biggest challenge facing Europe is to maintain a balance between controlling inflation and preventing economic recession. High inflation largely comes from supply shocks, and the central bank itself has no way to solve it. Europe may face a more difficult environment than the Fed in balancing inflation control and recession prevention.

"Relatively speaking, the U.S. economy is performing strongly. Before the Russia-Ukraine conflict, the inflationary pressure in the United States was significantly higher than that in the euro area. The Federal Reserve discussed and started normalizing monetary policy earlier. The difference between U.S. and European monetary policies will be in the second half of 2021. "One of the important reasons for the continued poor performance of the euro against the US dollar since then," Cao Yubo said, is that in order to deal with high inflation pressure, the European Central Bank's monetary policy normalization process is accelerating. If the euro zone economic recession is expected to continue to ferment and inflation peaks in the second half of the year. After a rapid decline, the European Central Bank may change its policy pace.

Will the European economy experience a recession? What are the implications of the Fed’s aggressive interest rate hikes?

Hu Jie said that treating high inflation caused by a damaged supply chain by reducing the money supply is similar to using the method of losing weight throughout the body to eliminate local lumps, which is inefficient and has serious side effects. However, inflation in Europe and the United States is dangerous, and the current options are limited, so we can only deal with it in this way. They will all pay a price in terms of both economic growth and unemployment.

The outlook for Europe is even more uncertain than for the United States. This is because the economic pressures facing Europe come not only from rising prices for energy, food and raw materials, but also from the switching costs of supply chain restructuring. Conversion requires an investment of time and money, and the European economy will inevitably decline before it returns to normal. It is estimated that the probability of a recession in the United States in the first half of next year is about 25%, while the probability of a recession in Europe is greater than 30%.

Hu Jie also said that the U.S. dollar interest rate hike will cause the euro exchange rate to fall further, which will be beneficial to European exports. However, rising U.S. dollar interest rates will lead to a downturn in the U.S. economy and even the world economy, which will reduce global demand for Europe and be detrimental to the European economy.

Wang Jinbin said that it is not yet possible to draw a conclusion whether there will be a recession in Europe. The Federal Reserve's aggressive tightening policy will cause the euro to continue to weaken, causing Europe's import costs to rise sharply and price levels to further rise. Therefore, the spillover nature of European monetary policy will have a relatively large impact on the entire European economic policy.

Cao Yubo said that in addition to the inflationary pressure caused by energy shortages, the Eurozone also faces higher debt risks. The Eurozone faces the dual pressure of "high inflation + high leverage". After the epidemic, in order to stimulate the economy, various countries launched various fiscal stimulus measures, resulting in an expansion of debt scale and an increase in fiscal deficit ratios. Currently, the leverage ratios and deficits of risk countries such as Italy, Spain, Portugal, and Greece are as follows: The rates of are higher than during the European debt crisis. Appropriate monetary easing is an important way to resolve debt risks, but in the context of rising global inflationary pressure, the Federal Reserve has begun the process of rapid monetary policy normalization, which actually limits the space for the European Central Bank to implement loose monetary policies . Therefore, factors such as inflationary pressure, debt crisis, and recession risks are superimposed. How regulatory agencies such as the European Central Bank currently respond is key.

Editor in charge: Zheng Jingxin Picture editor: Zhang Tongze