Economic activity across the eurozone posted a surprise improvement in August, with the manufacturing sector delivering an especially robust performance that served as the primary catalyst behind the better-than-expected headline figures. Concurrently, hiring across businesses has resumed, price pressures are continuing to ease, yet inflation remains well above the European Central Bank's objective, leaving the trajectory of monetary policy steeped in uncertainty.
Data released on 21 August showed the S&P Global-compiled eurozone Composite Purchasing Managers' Index (PMI) advanced to 52.1, up from July's 52.0 and marking a nine-month high. This reading also surpassed the 51.7 forecast from a Bloomberg survey and represents a second consecutive month of expansion. The manufacturing PMI climbed from 51.9 to 52.8, reaching its strongest level since May 2022, while the factory output index rose to 53.4, a 54-month peak. The services PMI held steady at 51.7, unchanged from the prior month.
Following the release, European bond markets ticked higher. Swap market data indicated traders marginally trimmed their bets on the scale of cumulative European Central Bank rate increases over the coming year, although expectations for a 25-basis-point hike in September remain near-certain.
Manufacturing resurgence fuels growth, buoyed by AI and defence demand
The manufacturing sector stood out as the most impressive component of the eurozone's August economic data.
Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, noted that manufacturing had "again been the star performer," with growth at its strongest in four and a half years. Beyond precautionary inventory rebuilding by companies, a recovery in demand for AI-related technology products and increased defence spending are driving improvements in equipment orders. New manufacturing orders increased for a second consecutive month, with the pace of growth reaching a 40-month high. Simultaneously, new export orders returned to growth for the first time in four and a half years, suggesting the sector's improvement extends beyond stock-building factors to include early signs of recovering external demand.
This shift carries particular significance for German industry. Output growth in Germany's manufacturing sector during August was the fastest since January 2022, with rebounding equipment demand helping to bolster the country's industrial performance. However, supply chain pressures persist, with notably longer vendor delivery times constraining manufacturers' ability to rebuild inventories.
Divergence within the eurozone remains apparent. German economic activity expanded modestly, while French activity contracted further. In contrast, other eurozone economies outside Germany and France recorded their fastest growth since April 2022. On the services side, rising tourism expenditure is becoming an important pillar of support for growth in regions beyond Germany and France.
From an overall economic standpoint, the eurozone continues to exhibit considerable resilience. Second-quarter output grew 0.4% quarter-on-quarter, exceeding earlier projections. Williamson estimates that the activity levels reflected in August's PMI readings imply eurozone GDP could expand by roughly 0.3% on a quarterly basis in the third quarter.
Companies resume hiring as economic improvement shows more positive signals
The PMI upturn extends beyond output and orders to the labour market, where a turning point has emerged.
Eurozone businesses increased headcount in August for the first time since the start of the year. Services hiring accelerated, while manufacturing employment edged higher, ending a 38-month streak of job cuts. Employment in Germany is stabilising, though French payrolls continue to decline, with new positions primarily arising in other eurozone member states.
Yet business confidence has not improved in tandem. Expectations for output over the coming year among eurozone companies fell to a three-month low in August, remaining below the long-run average. Sentiment weakened in the services sector, whereas manufacturing confidence rose to a six-month high.
This suggests the current improvement in economic activity retains an element of fragility, with firms adopting a cautious stance towards the growth outlook.
Inflation pressure eases further but remains well above target
Improved economic activity does not mean the European Central Bank can afford to be complacent, with inflation still the foremost challenge confronting policymakers.
The eurozone inflation rate rose to 2.9% in July, significantly above the ECB's 2% target. Having already delivered a 25-basis-point rate hike in June, the question of whether further monetary tightening is necessary amid resurgent inflation has become a key focus for markets.
Looking at the PMI price components, input cost inflation across eurozone businesses slowed to its weakest since February in August, with manufacturing input costs also rising at the slowest pace in six months. Output price inflation decelerated for a third straight month to its lowest level since March, with price pressures moderating across both manufacturing and services.
Nonetheless, input cost increases remain significant and still run well above levels seen prior to the outbreak of the Middle East conflict. This indicates that the impact of external shocks, including energy and supply chain disruptions, has yet to fully dissipate.
Williamson remarked that with third-quarter growth expected to remain robust, businesses having resumed hiring for the first time this year, and inflation still elevated by historical standards, the hawkish bias within the European Central Bank is likely to persist, meaning further rate increases in the near term cannot be ruled out.
The European Central Bank has previously cautioned that the full impact of the energy price shock has not yet been fully realised. The future trajectory of both eurozone economic growth and inflation will remain highly contingent on external conditions, particularly developments in the Middle East, supply chains, and energy markets.
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