News & analysis

For the first time in 10-months, both the French and German composite PMIs no longer signal economic contractions (at 49.9, the French composite PMI is essentially signalling no growth). The turnaround has understandably been driven by services activity, which in France jumped from 48.3 to 50.5 and in Germany rose from 50.1 to a 10-month high of 53.5.

By contrast, manufacturing activity in the eurozone’s two largest economies remained weak, printing at 44.9 and 42.4 respectively as firms reported dwindling new orders and weak export demand. In France, new manufacturing orders fell at the steepest pace since January amid reports of deteriorating demand from clients in overseas markets such as Germany, North America, and Africa. Similarly, in Germany, new factory orders fell at the fastest pace in five months and manufacturing exports also fell, albeit at the smallest rate in 12 months.

The two-speed recovery in the eurozone is also causing diverging trends in employment and inflation conditions. Across both economies, employment increases were solely driven by the services sector and the associated increase in wages was reported as the primary source of the steep increase in input prices.

Unlike recent months, the improvement in demand conditions is now allowing firms to pass on these higher wage costs to the end consumer, with overall inflation largely centred on services products across both economies. On the manufacturing front, however, firms in Germany and France reported diverging inflation dynamics. While manufacturers in Germany continued to report a fall in input costs and the sharpest decline in factory prices since September 2009 as firms vie for market share amidst weak demand, producers in France reported the sharpest rise in input costs since February 2023 and negligible cuts in output prices.

Europe’s services sector drags the overall economy into growth

All told, today’s PMI reports pose a bit of a conundrum for the ECB. On the one hand, manufacturing activity remains weak and warrants both an easing in monetary conditions and a depreciation in the euro to rectify the issue. In effect, this argues in favour of the ECB de-anchoring more from the Fed and embarking on a sequence of rate cuts from June. On the other hand, strong services activity is keeping labour market conditions tight and driving a re-emergence of inflation pressures. This warrants a more cautious stance moving forward as a string of rate cuts from June risks reflating the economy. This conundrum is further complicated by the presence of seasonal factors, which have seemingly intensified in the euro area since the pandemic.

Visible across both PMIs and official GDP data, euro area activity in the past two years has pricked up heading into the summer months where services activity tends to be strong, only to quickly drop off again in the subsequent months.

With the data posing more questions than answers for the ECB, it isn’t surprising that policymakers have generally shied away from giving explicit forward guidance from June and have instead kept the outlook for rates opaque. Markets too are taking a more neutral stance. Overnight interest rate swaps continue to factor just three rate cuts from the ECB across their next five meetings, essentially unchanged from yesterday, while the euro continues to fluctuate in its current 1.06-1.07 range despite the improved cyclical sentiment.

We think this is the correct response from traders given our doubts over seasonal factors and continue to see US data outturns as more influential for EURUSD this week.

Although the improvement in Europe’s PMIs provided EURUSD with a boost, the currency pair continues to trade in recent ranges



Simon Harvey, Head of FX Analysis



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