Significance

This was the lowest level since March 2004, with the deterioration in February broadly based on the business side. Consumer confidence was stable.

Implications

The overall tone of the survey indicates that Eurozone growth is likely to remain modest for the time being.

Outlook

Businesses seem set to remain cautious over their investment and, especially, employment plans for some time. Likewise, consumers are expected to limit their expenditures.

Sentiment Slumps

Overall economic sentiment in the Eurozone fell sharply in February, to its lowest level since March 2004, according to the European Commission's latest survey of businesses and consumers. The Commission's sentiment index for the Eurozone retreated to 98.8 in February, having briefly rallied to 100.8 in January from 100.2 at the end of 2004 and a 40-month high of 101.5 in October. The index had previously trended up to October's peak from 99.6 in mid-2004, 97.4 at the end of 2003 and a nine-year low of 89.4 in March 2003.

The deterioration in overall sentiment in February was widely based. Confidence fell back particularly sharply in the services sector; the index retreated to +10 from +13 in January. This was the equal lowest level (with December 2004) since October 2003, although it has been locked in a narrow +10 to +13 range since late 2003. In addition, the retail trade index relapsed to -8 in February, having improved to -6 in January (which matched the 2004 high) from -10 in November 2004. Furthermore, the construction sector sentiment index edged back to -14 in February, after reaching -13 in January and December, which had been its highest level since October 2002.

Industrial Sector Sentiment Falls for Third Consecutive Month

Particularly disappointingly, industrial sector confidence across the Eurozone weakened for a third month running in February, and at an increased rate, to stand its lowest level since March 2004. In contrast, it had stood at its highest level since March 2001 during September-November 2004. In recent months, confidence has been pressurised by high oil prices, the strength of the euro, evidence that global growth has lost some momentum compared to the first half of 2004 and persistently weak domestic demand in several Eurozone countries.

While oil prices fell back fairly markedly from their October record peaks in November and December 2004, they strengthened again in January and February. Indeed, Brent oil neared US$50/barrel again late in February.

Furthermore, the euro appreciated markedly in the final months of 2004 to reach a lifetime high of US$1.367 in late December. Although the euro has retreated overall during 2005 so far, even dipping under US$1.30 on occasions, it has remained relatively strong and there are still significant concerns that it could move higher against the US dollar over the coming months due to the sustained pressure on the latter currency stemming from the very high US current-account deficit.

Against this backdrop, the European Commission's index for Eurozone industrial sector confidence weakened to -7 in February. This was down from -5 in January, -4 in December and the peak of -3 in November-September 2004. The indicator had been as low as -14 in July 2003 and ended that year at -8.

The breakdown of the industrial sector confidence survey shows that the index for order books slumped to -15 in February, from -11 in January. Indeed, it had remained in a -11 to -12 range since July 2004. It had previously risen to this level from -15 in mid-2004, -21 at the end of 2003 and a low of -28 in July 2003. Export orders weakened in February, although less so than the overall orders index. It fell to -12 from -10 in January and a peak of -9 in July 2004. This index trended up to July's peak from -19 at the end of 2003 and -28 in July 2003. The fact that the export orders index peaked in July last year indicates that it has been affected to some extent by softer global growth in conjunction with the strong euro.

The index for production expectations in the Eurozone fell back to +6 in February, from +7 in January and an equal 2004 high of +11 in October. In fact, February's level was the lowest since December 2003 (when it also stood at +6), as the index was actually contained in a range of +8 to +11 throughout 2004. In addition, companies' views about recent production trends weakened in February. The index for this stood at +2, down from +4 in both January and December, and a peak of +7 last July. Meanwhile, companies were modestly more concerned about their stock levels of finished products.

Employment Expectations Still Soft

While the index measuring Eurozone industrial companies' employment expectations improved to -12 in both February and January, from -14 in December, it was still contained in the narrow -12 to -14 range that has existed since March 2004. Consequently, employment expectations have essentially seen no improvement over the past year, and the index remains not that far above the -17 level seen late in 2003 and the trough of -21 in June 2003 (the weakest level since 2001). Clearly, squeezed margins, the slowdown in Eurozone growth compared to early 2004 and some uncertainty about the global outlook are reinforcing companies' desires to keep their workforces as tight as possible in order to contain costs. Furthermore, in the services sector, the employment expectations index relapsed to +1 in both February and January, from +2 in December and +3 in November. This compares to the May 2004 peak of +5 and was only marginally up from the end-2003 level of +1.

Consumer Confidence Stable

Eurozone consumer sentiment was stable for a fifth month running in February, at its highest level since October 2002. Nevertheless, the overall improvement in consumer confidence from the March 2003 six-year low has been somewhat limited, as is evident from the fact that it has not improved since September 2004. The European Commission's consumer confidence indicator remained at -13 in February, after originally rising to this level in September last year from -14 in August-June 2004 and -16 at the end of 2003. The March 2003 trough was -21.

Although consumers have become less gloomy overall in recent months about the general economic situation over the past year, the economic outlook, their financial situations and unemployment, their concerns about these factors have far from disappeared. Indeed, their concern about future unemployment spiked back up in February to the equal highest level since mid-2004.

On a slightly encouraging note, consumers' willingness to make purchases over the next 12 months edged up in January and then stabilised in February, having seen no overall improvement in 2004. While this boosts hopes that consumer spending across the Eurozone will strengthen modestly in 2005 after persistent weakness, the index is still below its long-term average level, and it remains difficult to envisage any major improvement on a sustainable basis in consumption for the time being.

Specifically, the index improved to -18 in January and February, from -19 in December and -20 in November 2004. It had been locked throughout 2004 in a range of -19 to -21 (which was its lowest level since January 2001). The index's long-term average is -17.

Meanwhile, the index for consumers' willingness to make major purchases was also stable in February. It had improved in January, after suffering a relapse in both November and December 2004. This index recovered to -20 in January and February, after falling to a 2004 low of -23 in December. Even so, this was still significantly below the index's long-term average of -14.

Outlook and Implications

The overall tone of the European Commission's business and consumer survey for February reinforces our view that Eurozone growth is likely to remain modest for the time being, after slowing to 0.2% quarter-on-quarter (q/q) in the fourth quarter of 2004, from 0.3% q/q in the third quarter, 0.5% q/q in the second and 0.7% q/q in the first. We suspect that a number of factors will limit the upside to confidence and activity in the near term, at least. Consumers in most countries are likely to face soft labour markets for some months to come, while concerns and uncertainties persist about personal financial situations and some aspects of government policy, such as pension and labour market reforms.

Meanwhile, businesses still face subdued consumer spending in many of their home markets, while there are currently significant concerns and uncertainties about the global economic outlook. In addition, the strong euro and high oil prices remain significant problems for Eurozone businesses.

Finally, both businesses and consumers continue to have concerns about the strength and sustainability of the Eurozone upturn, partly reflecting the recent persistent weak economic performance of the region. Although sustained low interest rates and reduced government willingness to bring down their budget deficits at the expense of growth should help, we expect businesses to remain cautious over their investment and, especially, employment plans for some time. Likewise, consumers are expected to limit their expenditures. Survey and anecdotal evidence generally supports this view.