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Investor confidence in the euro zone and German economies collapsed in August, strengthening expectations that the European Central Bank will cut interest rates further next month.
The euro area’s ZEW economic confidence index fell 25.8 points to 17.9, the biggest drop since the early days of the COVID-19 pandemic in April 2020.
Germany, the euro zone’s largest economy, is suffering its worst recession in two years. The ZEW index fell 22.6 points in one month to 19.2, its lowest since the start of the year, nearly three times larger than analysts surveyed by Bloomberg had expected.
“Germany’s economic outlook is unraveling,” ZEW president Achim Wambach said, adding that “high uncertainty” due to the ECB’s “ambiguous monetary policy,” disappointing business data in the United States and growing concerns about an escalating conflict in the Middle East were worsening economic sentiment.
Alexander Valentin, a senior economist at Oxford Economics, said weakening investor sentiment provided “further reason for the ECB to cut rates in September and then again at the end of the year.” Weaker growth prospects, weaker industrial activity and a softening labor market “will make it more difficult for the ECB to maintain a hawkish stance,” he added.
German government bonds rose slightly on Tuesday after the survey results were released. The yield on the two-year German government bond, which is particularly sensitive to interest rates, fell 0.04 percentage point to 2.36 percent. The yield on the 10-year note fell 0.02 percentage point to 2.21 percent. Yields move inversely to prices.
Investors are expecting ECB policymakers to cut borrowing costs when they meet on September 12, slightly increasing the likelihood of a further rate cut when they meet in mid-October.
Robin Winkler, chief economist for Germany at Deutsche Bank, said optimism about Germany’s economic recovery that spread in the spring has “completely disappeared.” German gross domestic product unexpectedly fell 0.1% in the second quarter.
Tomasz Wieradek, chief European economist at T. Rowe Price, said the ZEW index’s sharp drop partly reflects recent volatility in global stock markets and concerns about the economic outlook.
“There is a risk that German GDP growth will contract this year,” he wrote in a client note, adding that Europe’s largest economy could even fall into a “self-fulfilling loop in which lower expectations lead to weaker growth.”
Willadek said the ECB would ignore the gloomy outlook for now but “would be more likely to act if actual GDP data showed weak growth.”
After the ECB’s last interest rate-setting meeting before the summer break in July, President Christine Lagarde said the September interest rate decision was “completely open” and that the central bank would decide based on new data that becomes available over the summer.
“If the data indeed confirm the ongoing deflationary process, it would strengthen our confidence in returning consumer price inflation to our 2 percent objective in the second half of 2025.”
The ECB kept borrowing costs unchanged at 3.75% at its July meeting after cutting interest rates from a record 4% the previous month.
The Mannheim-based economic think tank ZEW surveys up to 300 financial analysts from the finance departments of German banks, insurance groups and major corporations about their assessment of current economic activity and their outlook for the future. The index is seen as a reliable early indicator of macroeconomic trends.
Additional reporting by Emily Herbert in London
