Euro Area Economic Outlook: Leading Economic Index Signals Potential Downturn
The Leading Economic Index (LEI) and the Coincident Economic Index (CEI) are crucial tools for understanding the economic trajectory of the Euro Area. The LEI acts as an early warning system, indicating potential shifts in the business cycle and providing insights into the near-term economic direction. Conversely, the CEI offers a snapshot of the current economic climate. Recent data reveals concerning trends in the LEI, suggesting increased risks for the Euro Area economy.
The Conference Board Leading Economic Index® for the Euro Area experienced a further decrease of 1.0 percent in September 2023, reaching 101.8 (with 2016 as the base year of 100). This follows an identical decline in August, underscoring a consistent downward trend. Over the six-month period from March to September 2023, the LEI contracted by a significant 4.9 percent. This rate of contraction is more pronounced than the 3.7 percent decrease observed in the preceding six-month period from September 2022 to March 2023, indicating an accelerating economic slowdown.
This persistent decline in the LEI underscores a worrying economic trajectory for the Euro Area. The consistent negative movement suggests that the headwinds facing the Eurozone economy are not abating, and the likelihood of a significant economic downturn is increasing. Monitoring the LEI remains crucial for businesses and policymakers to anticipate and prepare for potential economic challenges.
Contributing to this negative trend, almost all components of the Euro Area LEI exhibited negative contributions in September, with the exception of the systemic stress component. This broad weakness across various economic indicators paints a concerning picture of the Euro Area’s economic fundamentals. Factors such as weakening manufacturing new orders, declining consumer confidence regarding future economic conditions, a negative yield spread, and pessimistic business expectations within the services sector have consistently weighed down the headline index for the past six months.
Elevated inflation continues to be a major concern, with the potential to be further exacerbated by volatile energy prices, particularly in the context of geopolitical instability. Tighter financial conditions, driven by rising interest rates aimed at curbing inflation, are also dampening economic activity. Furthermore, the lingering economic repercussions of the ongoing war in Ukraine continue to cast a shadow over the Euro Area, disrupting supply chains and contributing to uncertainty.
The persistent decline of the Euro Area LEI strongly suggests an elevated risk of recession in the near future. The “3D’s rule” – duration, depth, and diffusion – provides a framework for interpreting these LEI movements. Duration refers to the length of the index decline, depth to the magnitude of the decline, and diffusion to the breadth of weakening components. When the diffusion index falls below 50, indicating widespread component weakness, and the six-month decline rate falls below a critical threshold, it historically signals impending recessions. This rule highlights the severity and breadth of the current economic challenges indicated by the LEI.
In contrast to the LEI’s downward trend, The Conference Board Coincident Economic Index® (CEI) for the Euro Area showed a marginal increase of 0.2 percent in September 2023. However, this slight uptick was offset by downward revisions to July data, resulting in the CEI remaining at the same level as the previous month, at 108.0 (2016=100). The CEI’s growth of 0.3 percent over both the March to September 2023 and the preceding six-month periods indicates a sluggish but relatively stable current economic situation, even as the LEI points to future weakness.
Despite the CEI’s relative stability, the overriding message from the LEI is one of caution. Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators at The Conference Board, notes that “Risks of a downturn in the Euro Area economy have returned, as the Euro Area LEI declined again in September.” The Conference Board projects a modest year-over-year real GDP growth rate of 0.7 percent for the Euro Area in 2023. However, the continued weakening of the LEI suggests that achieving even this modest growth may be challenging, and the risks are clearly tilted towards a more significant economic slowdown.