Dismal Eurozone Manufacturing Data Could Force Interest Rate Cut

Speculation that the European Central Bank will be forced to slash interest rates has intensified in light of the most recent manufacturing data. The Markit Purchasing Manager’s Index (PMI) shows that for the second straight month, manufacturing in the Eurozone contracted due to weaker domestic demand and plunging export sales.

For the month of September, the index recorded a score of 48.5 compared to 49.0 in August. An index reading of less than 50 indicates a retrenchment meaning that for the second straight month, manufacturing in the Eurozone contracted.

This alone should be sufficiently alarming for Eurozone officials, but what the latest index reveals about the state of Germany’s manufacturing status, should be absolutely terrifying. Germany’s individual PMI reading for August was 50.9 – for September, the reading fell to just 50.3. While still indicating expansion, the PMI result is down considerably from the previous month and barely within the positive range.

Germany’s manufacturing sector is by far the largest manufacturing center within the Eurozone and is touted as the “engine” that will help power the Eurozone to recovery. If that is indeed the case, a tune-up is badly needed.
Until being surpassed last year by China, Germany was the world’s largest exporter with nearly $1.4 trillion (1.05 trillion euros) in sales estimated for 2010.

If German manufacturing continues to decline, there will likely be two immediate outcomes. Firstly, Eurozone unemployment will worsen as German manufacturing firms reduce worker headcount to address declining demand for manufactured goods. Secondly, this could very well serve as the catalyst that forces the European Central Bank to slash interest rates.

The combination of job losses and weaker export sales will bring pressure on the ECB to do more to boost economic activity within the debt-stricken Eurozone. In the wake of the last recession, the ECB initially resisted interest rate cuts and lagged behind the other major Central Banks in reducing lending rates. Starting in the final quarter of 2008, the Bank finally began implementing a series of quarter point rate cuts reducing the benchmark rate to 2.0 percent by January, 2009, and eventually to 1.0 percent by May.

The Bank then held the line on interest rates for almost two years before implementing two rate hikes increasing rates to 1.5 percent by July, 2011. With the exception of Australia and New Zealand, European interest rates remain well above the rest of the major economies, but the manufacturing data update may force the ECB to once again consider slashing interest rates.

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