The eurozone dodged a recession in the winter, thanks to unseasonably warm weather, a rollback in energy prices and China’s reopening after lifting COVID restrictions. However, European economies remain at risk of a recession if banking stresses intensify and core inflation — which excludes volatile food and fuel prices — lingers. An economic downturn is also possible if the war in Ukraine escalates, or the housing market slump worsens and spreads.

While recession appears to have been averted for now, there remains a strong possibility of substantially weaker economic growth later in the year as the lagged impact of higher interest rates feeds through to the economy, at the same time that the cost-of-living crisis has eroded real incomes.

The economic outlook for the German economy weakened in May as high inflation and monetary tightening take a toll on the economy. Investor’s confidence in Europe’s largest economy declined for a third month in a row reigniting fears for a recession.

The ZEW economic institute’s index of economic expectations for Germany fell to -10.7 in May, its lowest level in five months and significantly worse than market expectations of -5.3. ‘’The sentiment indicator decline is partly due to expectations of future interest rate hikes by the European Central Bank’’, according to the ZEW President Achim Wambach.

The European Central Bank has embarked its toughest monetary-tightening campaign in history with markets widely expecting 25-basis point rate hikes at each of the next two meetings as inflation remains high. This would bring the deposit rate to 3.75% in July with some economists expecting it to climb to 4% in September.

The ZEW index has turned back to negative territory for the first time since December. Mr. Wambach added that ‘’financial market experts anticipate a worsening of the already unfavourable economic conditions is expected in the next six months’’, highlighting the possibility of the German economy to enter a mild recession.

The German ZEW dropped for a third time in a row as growth optimism from the start of the year disappears. The index measure financial analysts’ assessments and expectations of economic developments. Recent weak German macro-economic data as well as U.S. debt ceiling concerns, banking turmoil and expectations of further rate hikes seem to have dented analysts’ optimism.

The ZEW readings came after a strong decline in industrial production and a drop in new manufacturing orders. Despite the strong consumer demand for services, doubts on how strongly the economy can rebound in the months ahead.

On Tuesday the International Monetary Fund warned that tighter financial conditions weigh on the German economy. The European Commission forecast German GDP to rise 0.2% in 2023 and 1.4% in 2024.

Source: Tradingview

Despite the deterioration in the macro-economic conditions the German benchmark index rebounded strongly in September 2022 with recent price action extending the rally close to its all-time high of 16,193.

While at this juncture in time there is no reversal signal evident on the daily chart, we note the formation of a triple bearish divergence between the price and the Relative Strength Indicator (RSI). The divergence shows that momentum conditions are deteriorating and suggests that the rally might be approaching an inflection point.

Given the proximity to key resistance and the weakening of the RSI indicator, the upside from here appears to be limited. Minor support of 15,662 and more importantly dynamic support of 15,390 are the two levels to be monitored in the short-term. A break below dynamic support will show the up trend is running out of steam and hints at a likely trend reversal.

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