The latest S&P Global Eurozone Composite PMI data for May indicates the region's economy is entering a classic period of stagflationary pressures, characterized by continued contraction in business activity, weakening demand, cooling employment, yet rising input costs and output prices. The PMI data shows the Eurozone's private sector activity index contracted at its weakest pace in 18 months during May, primarily due to a decline in demand for goods and services—a key health indicator for the economy. This marks the second consecutive month of declining composite PMI output, while cost pressures have surged to their highest level in over three years.
The Eurozone Composite PMI Output Index for May fell to 48.5 from 48.8 in April, marking its lowest level in 18 months. For the second month running, it remained below the critical 50-point threshold that separates expansion from contraction, signaling an accelerated pace of decline in private sector activity. S&P Global's Chief Business Economist, Chris Williamson, concluded that barring a significant improvement in June, the PMI data points to a risk of a quarterly GDP contraction of approximately -0.2% in Q2.
The overall S&P Global Eurozone Composite PMI Output Index declined from 48.8 in April to 48.5 in May, its lowest reading since November 2024, though it was higher than the preliminary estimate of 47.5. The headline Services PMI edged up slightly to 47.7 from 47.6, also outperforming the flash estimate of 46.4. Any reading below 50.0 indicates a contraction in economic activity.
Chief Business Economist Chris Williamson stated, "With Eurozone business activity declining for a second straight month in May, the likelihood of the economy contracting in the second quarter appears increasingly probable. Barring any significant change in June, the PMI data points to a quarterly GDP decline of 0.2%."
Overall new orders contracted for the third consecutive month, with the rate of decline being the second-steepest since November 2024. Overseas demand presented a greater drag, with export orders falling at the fastest pace so far this year. The deterioration was concentrated in the Eurozone's two largest economies. Private sector activity contracted in both Germany and France, while Italy and Spain recorded modest expansions.
Input costs rose at the fastest pace in three-and-a-half years, while prices charged to customers increased to a 38-month high—marking the third consecutive month of accelerating output price inflation. This follows data released on Tuesday showing the Eurozone inflation rate unexpectedly jumped to 3.2% in May, well above the European Central Bank's 2% target. With geopolitical conflict in the Middle East significantly driving up global energy prices for oil and gas, and the Strait of Hormuz remaining effectively blocked, Eurozone inflation is expected to rise further.
According to International Energy Agency (IEA) statistics, Iran's closure of the Strait of Hormuz may have already removed approximately 1 billion barrels of oil supply from the market to date, representing one of the largest historical disruptions to oil supply. Since the conflict involving Iran began in late February, the Strait of Hormuz has been effectively blockaded, severing one of the most critical shipping routes for supplying crude oil, natural gas, and refined fuel oil to global customers. This has sharply increased energy prices and intensified global investor concerns about inflation.
Financial giant Citigroup published a research note stating that if protracted peace negotiations between the US and Iran remain difficult, leading to a prolonged blockade and control of the Strait of Hormuz, the international oil benchmark—Brent crude—could rise further from its recent pullback near $100 per barrel, potentially even reaching new cyclical highs.
The European Central Bank has already noted that both upside risks to inflation and downside risks to growth have intensified, placing policymakers in a difficult position. Some economists suggest the ECB's June meeting will be pivotal, potentially announcing a 25 basis point rate hike to bring the benchmark rate to 2.25%. However, other economists argue that with the economy seemingly stalling and consumer confidence waning, the ECB should proceed cautiously before raising rates.
As the PMI report shows a decline in new business across the Eurozone, companies reported that spare capacity may continue to increase. The rate of job shedding accelerated to its fastest pace in five-and-a-half years, although the overall scale of layoffs remained modest. Concurrently, backlogs of work were depleted at the fastest rate in 14 months, indicating that firms are not completing more work due to capacity expansion, but rather because insufficient new orders are leading to a rapid reduction in unfinished business.
The survey also showed business confidence recovered modestly from April but remained weak by historical standards and well below levels seen prior to the outbreak of the Middle East conflict.
Stalled Growth and Resurgent Inflation: Energy Shock Tears Through European Economy
Particularly noteworthy is that the Eurozone labor market is also beginning to show signs of loosening. Private sector employment in the Eurozone fell further in May, with the rate of job cuts being the fastest in five-and-a-half years. Although the overall magnitude remains moderate, the direction is critical: the resilience of service sector employment has been a key support for persistent inflation in the Eurozone. Now, cooling employment suggests wage pressures may subside in the future, but it could also further dampen household income expectations and consumption willingness.
Service sector employment fell for the first time since January 2021, presenting a complex signal for the European Central Bank: it helps contain medium-term inflation but also means that if interest rates continue to rise, the risks of an economic downturn could be amplified.
The price component of the report carries the most significant policy implications. The rate of increase in input costs accelerated further in May, reaching its highest level in three-and-a-half years. Output price inflation rose to a 38-month high, accelerating for the third consecutive month. The S&P data report stated that input cost pressures remain the strongest since late 2022, with Chris Williamson even warning this could suggest inflation nearing 4% in the coming months. This aligns with the latest Eurostat data: the flash estimate for Eurozone headline inflation rose to 3.2% in May from 3.0% in April, with energy prices remaining a primary driver.
Demand-side data is also growing weaker. The report shows new orders for goods and services in the Eurozone contracted for the third consecutive month. Although the rate of decline slowed compared to April, it remained the second-steepest since November 2024. Overseas new orders constituted a more pronounced drag, with private sector export orders falling at the fastest pace so far this year. This indicates that Middle East conflict, energy price shocks, global trade uncertainty, and weakening external demand are impacting Eurozone companies' order books through the export channel.
In terms of macroeconomic policy implications, this PMI report pushes the European Central Bank into the dilemma of coexisting downward growth risks and upward inflation risks. The ECB kept its three key interest rates unchanged at its April meeting and explicitly stated that both upside inflation risks and downside growth risks had intensified. However, if the cost pressures indicated by the PMI continue to feed into final prices, markets will further bet that the ECB needs to raise rates to prevent inflation expectations from becoming unanchored. The problem is that the PMI also shows weakness in demand, employment, orders, and business confidence. If policy tightens excessively, it could equate to "raising rates during an economic downturn."
Consequently, Eurozone assets will undoubtedly continue to be constrained by a "stagflation discount." Bond markets will continue to face inflation risks and a rising term premium, while Eurozone equities are likely to favor defensive sectors, those with strong energy cost-pass-through ability, and stable cash flows. Cyclical consumer, export-oriented manufacturing, and highly leveraged sectors are expected to remain under pressure.
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