News & analysis

The eurozone’s flash PMIs made for grim reading yet again. While there are signs of a nascent recovery in Germany’s manufacturing sector, led by two consecutive months of slight growth in new orders, this provides just a slither of good news for eurozone producers as a whole seeing as the region’s manufacturing PMI has been in a slump for sixteen consecutive months now.

Furthermore, services activity is starting to crater too, bogged down by depressed consumer sentiment, the first signs of job cuts, and tighter monetary conditions. At 46.5, the eurozone composite PMI suggests that the ECB’s Q4 GDP projection of 0.1% QoQ is optimistic, unless there is a dramatic turnaround in growth momentum in the next two months. While a pause in the ECB’s tightening cycle suggests this may start to evolve as concerns over a further tightening in monetary conditions are eased, we don’t think this will materialise as business and consumer sentiment remains heavily depressed. This is likely to remain the case until 2024 too given risks tilt to the upside for energy prices and the effective tightness of financial conditions.

With Germany set to record a relatively deep technical recession in 2H23, and the trajectory of the French economy pointing towards a stagnation in Q4 at best, it wouldn’t be surprising to see a technical recession recorded in the eurozone over the winter months, even without the realisation of any further stagflationary shocks.

One glimmer of hope for the central bank, however, is that the weakening in demand conditions is now starting to weigh on inflation pressures, with output prices trending sideways in France and cooling in Germany even as input costs growth remains high. While it is early days, the data suggests firms are starting to absorb the higher costs in their profit margins as they are struggling to pass higher cost burdens onto the consumer given the softer demand conditions. Falling profits and reduced demand are starting to weigh on hiring intentions, with employment levels falling for the first time in close to three years in France due to layoffs in manufacturing, while employment fell more broadly in Germany, although again the manufacturing sector showed the most pronounced contraction as employment levels fell at the fastest rate since October 2020. This provides further evidence that the ECB’s actions are being effectively transmitted to the real economy and that further monetary policy tightening is unlikely, barring any further inflation shocks. That isn’t to say that monetary policy is effectively calibrated, however, as the current growth trajectory suggests a degree of over-tightening may have taken place.

This raises the risk of an earlier and more aggressive easing cycle in 2024 than markets are pricing – Dec 2024 Euribor futures imply just 70bps of cuts next year.

For markets, today’s release of October’s flash PMIs once again return attention to the eurozone’s deteriorating economic fundamentals. In the FX space, this has seen EURUSD trade back under pressure after it hit a fresh one-month high overnight on falling US Treasury yields. In our opinion, while falling US yields are likely to paint over some of the cracks, there is a limit to how much upside it can provide for EURUSD without coinciding with near-term expectations of Fed easing. Given the elevated risk of a more pronounced recession being recorded in the eurozone and the impact that will have on ECB policy in 2024, we believe EURUSD is subject to downside corrections at levels north of 1.05.

Such a retracement could ensue this afternoon should US PMIs once again show stark divergence in the US and eurozone growth outlooks, especially if the US data supports the Fed’s higher for longer narrative once again.




Simon Harvey, Head of FX Analysis


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