News & Analysis

Green shoots of recovery should not distract from the reality that eurozone activity remains in contraction, highlighted once again today by eurozone PMI figures.

The composite indicator rose to 48.9 this month,  a full point higher than the January print. Significantly though, the turnaround in headline figures is still short of levels consistent with an expansion in activity. These are, however, being accompanied by signs that price pressures are building once again. So, whilst the prospects for growth look like they are picking up for now, risks are also building that a nascent recovery is ultimately choked off by the ECB in light of sticky inflation pressures. As such, we are disinclined to revise higher our view for eurozone growth this year, and continue to expect that activity remains weak.

That said, today’s numbers do pose a challenge to our projection for the ECB, expecting that policymakers will deliver a first rate cut in April.

Instead, risks look increasingly skewed towards later start for policy easing. For the UK it is a different story. Robust growth and sticky inflation reinforce our call for the Bank of England to begin cutting rates in August. For GBPEUR today’s figures have proven net-neutral so far, with markets pricing out rate cuts for both the ECB and BoE in tandem.  Even so, in our view the better growth outlook for the UK relative to the eurozone should support upside for the pair in coming months.

A modest recovery in eurozone PMI numbers does little to hide the divergence between the UK and it’s continental counterparts

Perhaps the most notable feature of today’s PMI readings is the growing divergence between the eurozone economies.

Germany in particular stands out for all the wrong reasons once again, with a composite PMI reading that dropped from 47.0 to 46.1, led by a sharp slowdown in manufacturing. Here, the downturn appeared to reaccelerate with a PMI reading of 42.3, down on last month’s 45.5, reversing the measure’s recent upward progress. Admittedly, services did see a modest pick-up, with the PMI rising to 48.2, up from 47.7. But this was also accompanied by worrying inflation developments. Specifically, February’s data showed the fastest increase in business input costs for ten months, driven in part by strong wage pressures in services, where there were widespread reports of higher labour costs. Nor do forward looking indicators provide much reason for optimism either.

New business declined at the quickest pace for four months, with backlogs of work also falling. All told, the German economy looks to be in serious trouble.

In France, by contrast, tentative signs of stabilisation were notable. Though given a composite reading of 47.7, it is a stretch to call this unambiguously good news. Admittedly, the recovery in PMI readings was broad based. Services reading rose to 48.0, and manufacturing increased to 46.8, a decent improvement from the readings of 45.4 and 43.1 that were recorded for January, respectively. Moreover, even as the French economy added jobs in February, inflation continued to fall. These softening cost pressures resulted in the slowest increase in selling charges for three years, distinctly at odds with developments in Germany. Even so, backlogs of work continued to fall, as did new export business. So whilst the French economy seems to be staging the beginnings of a comeback, we are conscious of reading too much into one good month of data.

With Germany continuing to be a drag on the eurozone as a whole, and the French economy just barely pulling its own weight, it was left to the remainder of the eurozone to deliver the uptick in PMI readings seen today.

On this score, the improvement in services activity stood out, with the aggregate eurozone PMI managing to hit the 50-no change mark, the highest reading for seven months. In a notable similarity between Germany and the eurozone, this was also accompanied by signs of improving labour market conditions and resurgent price pressures. On the labour market front, employment has now increased in both January and February following two months of decline at the end of 2023. This appears to be stoking inflation, particularly in services where input costs rose at the sharpest rate for nine months and output prices accelerated for the fourth month in a row.  Neither of these are desirable for an ECB that is still concerned with risks of wage fuelled inflation, tilting risks towards a later start to policy easing than our current April forecast.

Whilst eurozone PMIs offer a troubling outlook for the economy on the continent, UK readings are continuing to do precisely the opposite.

The flash composite PMI rose to 53.3 in February to record a nine-month high, up from the 52.9 recorded in January. The continued expansion in activity was largely a result of services where the PMI stabilised at a very healthy 54.3 this month. Significantly, this was accompanied by an uptick in new business volumes, improving order books and rising business optimism, suggesting a positive outlook for activity going forwards. The Bank of England might not take such a sanguine view of today’s figures, however, especially as the report noted that average cost burdens increased sharply. Not only was this the fastest pace of increase for six months, largely due to higher labour costs. But these pressures are being transmitted to output prices too, with output charges accelerating at the fastest rate since July 2023. That said, we do not think that this is likely to trigger full-on panic in a broader context. Specifically, job creation was unchanged from January and hiring remains subdued with firms highlighting a need to reduce overheads, suggesting that wages pressures should continue to soften through the year. Instead, this should serve to keep the BoE on hold into the second half of the year. We see this as further reinforcing our call for a first BoE rate cut to come in August.



Nick Rees, FX Market Analyst


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