Economic data for June from the Eurozone presented a mixed picture: inflation cooled more than anticipated, creating room for the European Central Bank to pause its rate hikes, while manufacturing output registered its strongest quarterly performance in nearly four and a half years, indicating underlying resilience in the real economy. These developments are closely tied to dramatic shifts in the geopolitical landscape of the Middle East.
Inflation Shows Broad-Based Cooling
Data released on Wednesday showed the Eurozone's headline Consumer Price Index (CPI) rose 2.8% year-on-year in June, a significant deceleration from May's 3.2% and notably below market expectations of 3.0%. This marks a striking decline in the inflation rate following the energy crisis. Core inflation, which excludes volatile food and energy prices, also provided a positive surprise, dropping to 2.4% from 2.6% in May. More crucially, services inflation—a key indicator for the ECB of domestic price pressures—fell sharply from 3.5% to 3.2%. Among the bloc's three largest economies, price growth in all was slower than forecast, with French inflation even dipping to the ECB's 2% target level. The broad-based deceleration in food, energy, and services prices is largely attributed to increased market bets on Middle East peace prospects. News of ceasefire negotiations directly led to a significant pullback in previously surging international oil prices, lowering energy costs and indirectly easing broader price pressures.
Manufacturing Sector Demonstrates Resilience
Concurrently, a survey released on Wednesday revealed the Eurozone manufacturing sector displayed encouraging resilience amid soft demand. The final Eurozone Manufacturing Purchasing Managers' Index (PMI) for June edged down to 51.4 from 51.6 in May, a four-month low, but remained above the 50.0 growth threshold for a fifth consecutive month and was slightly better than the preliminary reading of 51.3. More encouraging was the performance on the output side. The manufacturing output sub-index rose to a two-month high of 51.7 from 51.3, providing a strong finish to the second quarter. The chief business economist at the data provider noted that June's expansion marked "the strongest quarter for production performance in the Eurozone manufacturing sector since early 2022," partially offsetting recent weakness in the services economy and showcasing the bloc's economic resilience. Demand also showed a modest improvement, with new orders returning to slight growth in June after stagnating in May, although export orders remained a slight drag, indicating external demand remains soft. Among the countries surveyed, only Spain and France recorded a decline in output.
Cost Pressures Ease, Supply Chain Strains Alleviate
The effects of geopolitical de-escalation are gradually filtering through to supply chains. Data shows the suppliers' delivery times sub-index rose to a three-month high, indicating a moderation in conflict-related supply disruptions. In response to earlier uncertainties, manufacturers had heavily drawn down precautionary inventory holdings, leading to a marked contraction in pre-production stocks. On the pricing front, while input cost inflation remained elevated, it slowed to its lowest rate since March, ending a period of acceleration that began last September. Output price inflation also fell to a three-month low. The report noted the cooling cost pressures "largely reflected a steep fall in oil prices during the month and an easing of supply concerns." However, it was specifically mentioned that most survey responses were collected before a significant geopolitical development on June 17, meaning the data does not yet fully reflect the potential positive impact of that event. The economist also cautioned that uncertainty remains over whether positive shifts in the Middle East situation will translate into sustained improvement for manufacturing. While lower energy prices and improved supply can directly reduce business costs and, by dampening inflation, boost consumer demand, the beneficial effect of precautionary stockpiling seen in recent months is waning and could become a drag on growth in the coming months. Other survey data showed that while manufacturing employment continued to decline, the pace of job shedding slowed, reflecting companies' continued caution in adjusting their workforce amid an uncertain demand outlook. Business confidence improved for a second consecutive month, rising to a four-month high and continuing a rebound from a 17-month low in April, though it remained slightly below the long-run historical average.
ECB Gains a Window for Patience, but Tightening Not Over
The dual data on inflation and the real economy has temporarily tilted the ECB's decision-making balance towards a wait-and-see approach. Due to the energy price shock, the ECB raised its deposit rate by 25 basis points in June, its first hike since 2023, aiming to combat inflation that had once breached 3%—far above its target. The current gentle retreat in price pressures, however, significantly strengthens the case for policymakers to pause follow-up action for now. Several ECB officials have indicated, publicly and privately, that there is no need to rush into another hike immediately after June's move at the July meeting, and they can afford to take time to observe how price pressures evolve. The ECB has been particularly concerned that the initial energy shock could spread to other goods and services prices and ultimately push up wages. However, such "second-round effects" have not yet materialized, and wage pressures have not accelerated. At a recent ECB forum, the head of the German central bank stated that while the oil price decline was a surprise, how the fragile Middle East situation develops remains to be seen, and he is "keeping options open for both the July and September meetings." The ECB's chief economist emphasized the need to examine how the recent rise in energy costs will "pass through to food inflation and services inflation." Markets widely expect the ECB to pause at its next policy meeting on July 23, but a strong majority of economists and investors still anticipate another rate hike in September or October. Market pricing suggests the ECB could deliver one more 25-basis-point hike by year-end, bringing the deposit rate to 2.5%. However, as cooling energy markets reduce extreme policy scenarios, market bets on a more aggressive tightening path have moderated.
Looking ahead, risks have not fully dissipated. Energy prices remain above pre-conflict levels, and the Middle East situation has seen multiple unexpected turns, keeping price expectations volatile. Furthermore, fertilizer shortages in the Middle East and potential heatwaves across the European continent could reduce crop harvests and exert renewed upward pressure on food prices even as energy costs retreat.
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