Monex Europe: Eurozone PMIs show no reprieve in core inflation for the ECB

February 21, 2023

Commenting on today’s Eurozone PMI increase, Simon Harvey, Head of FX Analysis at Monex Europe, said:

“In France, the composite PMI printed above 50 for the first time since October 2022. While growth was modest, economic activity expanded at the fastest rate since July 2022. Meanwhile in Germany, where the composite reading is more influenced by manufacturing conditions, overall activity as measured by the PMI survey expanded for the first time since June 2022, when the composite reading measured slightly above that of this month at 51.3.

The eurozone-wide measure, by comparison, saw overall activity conditions improve more considerably with a composite reading of 52.3. Following a January reading of 50.3, the acceleration in the pace of economic expansion at a eurozone level is consistent with a positive GDP reading for Q1.

On the surface, the improvement in growth conditions was driven by increased service sector activity. However, economic activity within the manufacturing sector wasn’t as bad as the main measure suggests, as it was depressed by falling input purchases as supply chain conditions improved.

In normal times, lower purchases of inputs are suggestive of a weakening demand outlook and as such has a negative contribution to the headline figure. However, similarly to how increasing supplier delivery times synthetically propped up the manufacturing PMI at the start of the pandemic, the unwinding of this pandemic-effect is leading to the overall manufacturing PMI misrepresenting the true health of the sector. This is highlighted by the fact that in both Germany and the eurozone, the manufacturing output index rose above the breakeven 50 level to a respective 9-month high in February.

Additionally, unlike in previous months, this improvement in the level of goods output wasn’t driven primarily by firms eating into order backlogs. While it did play a part, the overall decline in backlogs was the smallest seen for six months. This likely reflected the recent improvement in new orders.

While the ECB will welcome the improvement in overall growth conditions and signs that supply chains are correcting to the extent that they are considerably weighing on input costs, the better growth outlook indeed comes at a cost. Employment levels remain elevated and services firms specifically are highlighting that tighter labour markets are filtering through into higher input costs. In France, the rate of increase in operating expenses at services firms is still close to its series peak, with firms mostly attributing this to higher salaries. While in Germany, service sector input prices continued to accelerate in February, driven in part by higher wage costs.

Although at a eurozone level the prices charged for goods and services moderated from January, the rate of increase continues to be elevated, especially within services. As new order growth and business confidence picks up as the economic upswing continues, these upstream prices are likely to filter through to the consumer as firms aim to rebuild their profit margins.

If employment growth and higher wage pressures remain visible in the services sector in the upcoming PMIs, and firms start to show increased willingness to pass this onto the consumer, the ECB may well be forced into a 50bp hike at their May meeting. Signs of this eventuality will undoubtedly lead markets to imply a higher terminal level from the ECB, which currently sits just 63bps above the current deposit rate at 3.63%.”