Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Factory Output Is Diverging Sharply in 2026
Transcript
- Lucas: Luna, I've been staring at the June manufacturing PMIs for the Eurozone, and the headline number — 45.2 — is the worst reading since late 2020. But the real story isn't the average, it's the split. Luna: Right, because Germany is dragging the whole index down, but some countries are actually holding up? Lucas: Exactly. Germany's manufacturing PMI dropped to 43.4 in June. That's a 44-month low. Factory output there has contracted for eleven straight months. But Spain came in at 51.2, still in expansion territory, and Italy at 49.8, barely below the 50 boom-bust line. So we've got a two-speed factory Europe. Luna: That's a huge gap. What's driving it? Energy costs seem like the obvious culprit for Germany. Lucas: Energy is part of it. German industrial electricity prices are still about 40 percent above pre-pandemic levels, even after the recent declines. But there's also export demand. Germany is heavily exposed to Chinese demand, and China's manufacturing PMI has been below 50 for most of 2026. Meanwhile, Spain and Italy have more domestic-oriented manufacturing and are benefiting from the recovery in Eurozone domestic demand. Luna: And tourism. Southern Europe's service sectors are booming, which creates some spillover demand for local manufacturing — packaging, food processing, construction materials. Lucas: That's a great point. The services PMI for the Eurozone came in at 53.5 in June, still solidly in expansion. So the service sector is pulling manufacturing along in those countries. In Germany, the link is weaker because its service sector is also more subdued. Luna: What does this mean for the ECB? Christine Lagarde has been trying to normalize rates, but if Germany's factory sector is in recession while Spain is growing, how do you set one policy rate for the whole bloc? Lucas: That's the perennial problem. The ECB's last rate decision in June held the deposit rate at 3.25 percent. The market is pricing a cut in September. But if you look at the data, the case for a cut is strong in Germany and weak in Spain and Italy. The ECB is in a bind. Luna: And the euro itself is caught in the middle. The trade-weighted euro has weakened about 2 percent in the last month, partly on expectations of a cut. A weaker euro helps German exporters, but it also raises import costs for energy, which hurts everyone. Lucas: Right. The euro is at 1.15 against the dollar, down from 1.16 a week ago. That's not a huge move, but the trend is clear. Markets are betting the ECB will have to ease more than the Fed, and that's putting downward pressure on the currency. Luna: So if you're an investor looking at Eurozone equities, this divergence matters a lot. French and German stocks are more exposed to manufacturing, while Spanish and Italian indexes are more service-oriented. Lucas: Exactly. Look at the Italian stock index, the FTSE MIB, which is up 6 percent year-to-date. The German DAX is flat. That performance gap mirrors the manufacturing divergence. Investors are voting with their feet. Luna: And the French CAC 40 is down about 2 percent this year, partly because of political uncertainty, but also because it has a lot of industrial exposure. Lucas: Right. So the question is: will the manufacturing weakness in the core spread to the periphery, or will the periphery's service strength eventually pull the core along? The data so far suggests the former is more likely, but it's not inevitable. Luna: One thing that might help is the recent drop in energy prices. Natural gas in Europe is down about 30 percent from a year ago. That should eventually feed through to lower production costs for German manufacturers. Lucas: It should, but it takes time. And there's another risk: the escalation of trade tensions with the US. The Biden administration has been talking about tariffs on European goods, and that would hit Germany hardest. Luna: You know, this kind of granular data — real economic splits within the bloc — is exactly why we do this show. If you find these conversations useful and want to help us keep the podcast ad-free and independent, you can support us at buy me a coffee dot com slash fexingo. It's a simple way to chip in. Lucas: Yeah, and it really does make a difference. Every contribution helps us dig into the data and bring you these stories without any sponsor pressure. So if you're in a position to, we'd appreciate it. Luna: Alright, back to the data. Lucas, you mentioned the PMIs — what about actual industrial production figures? The PMI is a survey, but the hard data for April came out last week. Lucas: Yes. Eurozone industrial production fell 0.8 percent month-on-month in April, following a 0.5 percent rise in March. Germany was down 1.7 percent, while Spain was up 0.9 percent. So the PMI survey is consistent with the real data. Luna: And the forward-looking indicators like new orders — the PMI new orders index for Germany was 41.2 in June, suggesting more pain ahead. Lucas: That's the most worrying number. New orders have been below 50 for 22 consecutive months in Germany. At some point, that has to translate into more layoffs. The German unemployment rate ticked up to 6.1 percent in May from 5.9 percent in April. Luna: And yet, consumer confidence in the Eurozone has actually improved a bit. The European Commission's consumer confidence indicator for June rose to minus 12.4 from minus 14.0 in May. So households are feeling better even as factories struggle. Lucas: That's the puzzle. It's partly because the labor market is still tight overall — the unemployment rate is at a record low of 6.4 percent for the bloc. So people have jobs and their wages are rising, even if manufacturing is weak. Luna: So the consumer is keeping the economy afloat, but the industrial engine is sputtering. That's not a sustainable mix forever. Lucas: No, it isn't. Eventually, if manufacturing continues to contract, it will start to weigh on hiring and wages in the service sector too. But for now, the divergence is giving the ECB a headache — and creating opportunities for stock pickers. Luna: Let's talk about those opportunities. You mentioned Italian stocks outperforming. Are there specific sectors within Italy that are driving that? Lucas: Financials are a big part of it. Italian banks like Intesa Sanpaolo and UniCredit have been benefiting from higher interest rates and lower non-performing loans. They're up 15 and 12 percent year-to-date respectively. Also, luxury goods — companies like Moncler and Ferrari — are less exposed to the manufacturing cycle and more to global demand. Luna: And in Spain, it's tourism and infrastructure. Hotel occupancy is at 85 percent in June, and construction is booming on the back of EU recovery funds. Lucas: Exactly. So the investment story is really about which countries and sectors are riding the service wave versus being stuck in the manufacturing trough. It's a very European kind of divergence. Luna: What about the European Central Bank's corporate bond purchases? They've been slowly reducing their holdings, but they still own a lot of corporate debt. Could that be distorting the market? Lucas: It's possible. The ECB still holds about 340 billion euros in corporate bonds. That's down from a peak of 380 billion, but it's still a big presence. It keeps borrowing costs low for larger companies, which might be masking some of the stress in smaller firms. Luna: And smaller firms are typically the ones that rely on bank lending, not bond markets. The ECB's bank lending survey for the second quarter showed that credit standards for small and medium enterprises tightened again. Lucas: Right. So the larger companies in Germany can issue bonds at low rates, but the Mittelstand — the small and medium-sized enterprises that are the backbone of the German economy — are finding it harder to get loans. That's where the real pain is. Luna: All of this feeds into the question of whether the Eurozone is heading for a recession. The big economies — Germany, France, Italy — are all growing very slowly or not at all. The only bright spot is Spain, with GDP growth of 2.5 percent annualized in the first quarter. Lucas: And the overall Eurozone GDP growth was 1.2 percent annualized in Q1, up from 0.5 percent in Q4. But that was driven by services. If manufacturing keeps contracting, Q2 and Q3 could be weaker. The consensus is for about 0.8 percent growth this year. Luna: That's not a recession, but it's sluggish. And with the ECB still cautious on rate cuts, the risk is that they wait too long and the manufacturing weakness spills over into the broader economy. Lucas: I think that's the key risk for the second half of 2026. The ECB is walking a tightrope between inflation, which is still above target at 2.6 percent for headline and 3.1 percent for core, and growth, which is fragile. The divergence we're seeing in manufacturing just makes that balancing act harder. Luna: It also means that any policy response will have uneven effects. A rate cut might help German manufacturers, but it could overheat the Spanish property market, which is already seeing double-digit price growth in some cities. Lucas: Exactly. There's no one-size-fits-all solution. And that's the reality of the Eurozone — it's a monetary union without a fiscal union, so the ECB has to do its best with a single instrument. The rest is up to national governments. Luna: And that brings us back to where we started. The data is telling us a story about divergence. And for anyone trying to understand the European economy, following the manufacturing numbers — and the splits within them — is essential. Lucas: Absolutely. We'll be watching the July PMIs closely. If Germany's new orders don't stabilize, the conversation about a deeper downturn will get louder. Until then, it's a tale of two Europes.