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Today is a big day as far as the ECB is concerned, with not one but two key pieces of data being published this morning.
The first of these, Eurozone PMIs, saw headline prints broadly in line with expectations. A modest undershoot in France was offset by similarly marginal outperformance in Germany. This left the aggregate eurozone reading at 52.3, just fractionally above consensus expectations of 52.0 and a small rise on last month’s 51.7 reading. While the headline figures pointed to a modest improvement in eurozone growth, representing welcome news in isolation, we suspect that inflation indicators were the main thing catching the ECB’s attention. Specifically, while input costs rose sharply, output charges fell in May. This suggests only limited wage passthrough to inflation and a reversal of the worrying strength indicated in last month’s report. Such a dynamic takes on additional significance in light of today’s negotiated wage release too. This showed that pay growth accelerated at the start of 2024, rising to 4.7% in Q1, up from 4.5% at the end of last year. Taken as a whole, this still should be sufficient to keep the ECB on track to ease in June, even with the rise in wage growth. Beyond this, however, we think today’s data likely favours the ECB hawks on balance, an outcome that has led the euro modestly higher this morning.
Digging through today’s data in a little more detail, services continue to underpin the eurozone expansion with activity rising for a fourth consecutive month.
Manufacturing output, in contrast, fell once again. Looking forward, indications are that the pace of expansion is set to be sustained. New order growth strengthened in May, in turn spurring an uptick in employment, with business confidence the highest since February 2022. Given this improving outlook, there is naturally a growing risk that firms begin to feel more comfortable passing on rising wage costs to consumers. Indeed, the April PMI report pointed at exactly this dynamic. Today’s PMI report, however, did not.
While input costs rose strongly, driven by services, output price inflation softened to the weakest level since November 2023.
Against this backdrop, today’s acceleration in negotiated pay is likely to be a little less concerning for the ECB. If firms are failing to pass on rising costs, then a strong increase in wages will ultimately have only a marginal inflation impact. That said, it is still true that the 0.2pp acceleration in negotiated wages at the start of 2024 shows wage growth moving in the wrong direction for ECB policymakers. Moreover, it is clearly also too high to be consistent with 2% inflation in the medium term. But drill down into the details, we think there is more room for comfort. Specifically, the unexpected strength seen in these latest figures appears to stem from one country in particular, Germany. Here an acceleration in negotiated wages saw pay growth jump to 11.7% YoY in March, far above the 5.9% seen the month prior. But with this largely the result of one-off payments, and with pay growth across other major economies tracking at more modest levels, there is good reason for the Governing Council to treat these figures with a degree of caution, rather than as a cause for outright panic.
Taken as a whole, we are inclined to think that the modest uptick in wage growth and resilient activity is likely to outweigh a signal of reduced wage pass through for ECB policymakers.
As such, while we still think a June rate cut is all but guaranteed based on the consistency of recent commentary, today’s data weighs in favour of the ECB hawks’ argument for a relatively slower pace of easing in H2. Broadly speaking markets appear to have reached a similar conclusion too. Easing expectations for 2024 have been modestly trimmed, with markets now projecting slightly less than 2.5 cuts for the entirety of 2024. This has seen the euro make modest gains against the dollar so far today, with EURUSD up 0.2pp following this morning’s latest round of data.
Author:
Nick Rees, FX Market Analyst