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Business climate indicators in the eurozone weakened significantly in June. In the manufacturing sector, this is due to the persistent constraints on production, with no hope of an easing in the foreseeable future given the war in Ukraine and the related energy crisis. In services, as expected, the post-Omicron reopening effect is wearing off. Current conditions are eroding moderately, particularly on the employment front, but the outlook for demand is declining sharply against a backdrop of inflationary pressures. To make matters worse, the ECB has triggered a severe tightening of financial conditions.

Below normal

Since the outbreak of the war in Ukraine four months ago, the interpretation of European business confidence surveys has given rise to mixed sentiment. While there were signs of weakness -the opposite would have been surprising given the suddenness and severity of the shock- they were neither diffuse enough across sectors nor strong enough to signal a significant downturn. Moreover, as this war started when morale was well above normal, it left a safety buffer before hitting critical levels. There is no longer any ambiguity in the signals sent by eurozone businesses in June: they are all negative.

According to the flash estimates of the PMI surveys conducted from 13 to 21 June¹, the downturn has become markedly more pronounced in all countries and sectors (table). In the manufacturing sector, purchasing managers' confidence fell for the fifth month in a row. In the services sector, which had previously found significant support in the catchup following the abating of the Omicron wave, it is the second consecutive contraction. In the eurozone, the business climate indices remain above the "critical threshold" for entering a recession (50 points) but all have fallen below their pre-Covid levels. This portends a slowdown in economic growth in the second half of 2022.

Moreover, given the state of EU-Russia relations, the disruption of supply-chains and inflationary tensions stoked by the war in Ukraine are not about to abate. Sanctions on the one hand, and reduced gas supplies on the other, all kindle fears of shortages. It is quite possible that European governments will have to ration energy distribution in the coming months, at least they are working on such contingency plans. In this extreme situation, there can be no doubt that this would cause a contraction of activity. Countries with a large industrial sector are most directly exposed. Germany is in the front line in this regard².

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