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March flash PMIs continue to highlight the contrasting fortunes of European economies. Whilst Eurozone PMIs nudged higher in March, bringing the composite reading to 49.9 to suggest the slump in activity is almost at an end, this improvement hides a growing divergence between France and Germany on the one hand, and the rest of the eurozone on the other. The UK, meanwhile, continues to outperform.
While the headline UK reading modestly undershot consensus expectations and eased fractionally from last month, a composite print of 52.9 still indicates that economic activity continues to expand at a respectable pace, particularly when compared to its neighbours on the continent. All told, today’s reports should do little to change the narrative for either the ECB or the Bank of England. Weak growth and softening inflation should see the former easing in June. The latter, in contrast, will find no reason in these March PMI figures not to delay easing until the second half of the year, with price pressures looking stickier and an economy able to withstand higher for longer rates.
Looking through the eurozone PMIs in detail, as has been the case over recent months, divergence is once again the major theme.
A respectable expansion in services, where the flash March PMI printed at 51.1, up from 50.2 last month, was offset by an underwhelming manufacturing print which slid from 46.5 to 45.7. As might be expected, with no ending in sight for Europe’s manufacturing recession, employment growth and inflation pressures remain contained to the services sector. For the eurozone as a whole, this saw employment increase for a third straight month, albeit the pace of growth has slowed. So too has the rate of input cost growth, though where input cost pressures have persisted, most notably in services, this was often linked to higher wage bills. Crucially for the ECB, however, selling price inflation continues to moderate, cooling for the first time in five months, suggesting profit margins continue to narrow.
This suggests that even where resilience is being observed, it is not translating into the kind of inflationary pressures that should keep policymakers concerned.
Divergence is similarly playing out on a cross-country basis, with the eurozone’s two biggest economies seeing a further contraction in activity in March. Granted, the composite reading for Germany nudged up to 47.4 from 46.3, but the French print fell 48.1 to 47.7, with both readings below the 50 no-change mark in any case. While at the aggregate level this was offset by better growth elsewhere in the bloc, individually, the failure of either French or German economies to show signs of improvement raises significant concerns around the resilience of the European growth engine.
That said, there were some notable commonalities across eurozone economies that should not be overlooked by policymakers. Employment gains continue to be weak, suggesting the wage pressures that have so concerned the ECB, should be set to ease.
Most significantly, the country reports for both France and Germany saw softening input costs, paralleling overall eurozone figures, with both countries similarly seeing this translate into slowing output charges. In Germany’s case this now means that output price inflation has now dropped to levels broadly in line with its historical average, while in France the series hit a 37-month low in this latest round of figures.
The UK in contrast continues to see a robust expansion in activity, particularly in services, albeit the March PMI for this sector did ease marginally from 53.8 to 53.4. Surprisingly, the normally softer manufacturing PMI rose from 47.5 to 49.9, essentially signalling that output for the sector has now stabilised, having been in contraction for close to two years. All told, this still leaves activity in the UK looking notably stronger than on the continent, a dynamic that means BoE policymakers face a rather different problem than their ECB counterparts. While private sector employment stagnated in March according to the latest PMI report, input costs continued to increase sharply, as did prices charged. The latter measure is now the highest recorded since July 2023, led by increases in the services sector. In fact, the report notes anecdotal evidence that higher salary payments were the main factor driving increased output prices across the service sector.
In part we suspect this is due to firms beginning to raise wages and costs in advance of the official National Living Wage rise in April, an effect we expect to subside over coming months, but one that should keep policymakers cautious for now.
Taken as a whole, today’s eurozone PMIs show signs that labour market gains are slowing and that price pressures have eased in turn, all while activity indicators remain disappointing, which should point towards the need for an imminent pivot by the ECB towards rate cuts. This is particularly true in an environment where the eurozone’s two most important economies continue to struggle and look destined to do so until the ECB provides some relief. Without an improvement in activity for either France or Germany, growth for the bloc is condemned to remain weak at best. While this is unlikely to trigger a rate cut in April for the ECB in our view given the tone of recent messaging from a plurality of ECB speakers, today’s reports should add further support to begin easing in June, and continue easing rapidly thereafter.
In comparison, with the BoE already worried that increases in pay would translate into output inflation in the UK, today’s report is unlikely to allay any fears on the MPC. Even so, these signs of inflationary stickiness should keep the BoE on hold for the time being, reinforcing our call for no rate cuts to be delivered before August. On this basis alone, we suspect further GBPEUR upside is in store once diverging easing cycles commence.
Author:
Nick Rees, FX Market Analyst