Economic activity in the eurozone saw a clear improvement in July, with the composite PMI returning to expansion territory and significantly exceeding market expectations. Both the German and French economies have shown signs of a turnaround. However, as tensions between the US and Iran escalate once again, oil and gas prices are coming under renewed pressure, posing risks of inflation and supply chain disruptions that could undermine this recovery momentum.
Latest data from S&P Global shows that the eurozone's July Composite Purchasing Managers' Index (PMI) rose to 51.9, crossing the 50-point threshold to re-enter expansion territory. This figure is well above the median forecast of 50.2 from a Bloomberg survey of economists and exceeded the expectations of nearly all respondents.
Both the German and French economies performed better than anticipated. Germany's Composite PMI increased from 49.5 to 51.2, ending three consecutive months of contraction. France's Composite PMI climbed from 47.2 to 49.6, its highest level since the outbreak of the Middle East conflict.
However, market concerns are growing that, with the renewed escalation of US-Iran military tensions, rising international oil and gas prices could reignite inflationary pressures and dampen business and consumer confidence. The European Central Bank held interest rates steady on Thursday, but sources cited by reports suggest officials still lean towards discussing further rate hikes in September.
Economic recovery in Germany and France drives eurozone back into expansion
The eurozone's July Composite PMI stood above the 50-point mark for the first time since March, with overall economic activity returning to levels seen before the start of the Middle East conflict.
Germany was a primary driver of this improvement. The country's Composite PMI rose to 51.2, with the manufacturing sub-index jumping to 52.2, a four-month high. While the services sector also showed improvement, it remained in contraction territory. Phil Smith, an economist at S&P Global Market Intelligence, noted that the German economy has made a positive start to the third quarter, but the sustained recovery still faces uncertainty due to recent regional tensions and rising global energy prices.
The French economy also showed signs of improvement. The July Composite PMI for France reached 49.6, its highest level since February, primarily driven by the services sector, which posted a PMI of 49.8, its strongest reading since last December. The manufacturing sector, in contrast, was relatively weak and remained close to the contraction threshold.
Joe Hayes, a senior principal economist at S&P Global Market Intelligence, cautioned that expectations for a continued recovery in the French economy might be overly optimistic, considering the recent resurgence of pressure in the oil and gas markets.
Inflation pressures ease, but energy risks re-emerge
The July PMI survey indicated a clear easing of cost pressures within the eurozone, falling to their lowest level since the outbreak of the Middle East conflict. The pace of increases in selling prices for goods and services also moderated in tandem. Chris Williamson, chief business economist at S&P Global Market Intelligence, stated that the decline in cost pressures would "reduce the urgency for further emergency rate hikes by the European Central Bank."
The European Central Bank, which was the first G7 central bank to raise interest rates in response to the Middle East conflict, chose to hold steady this Thursday. David Powell, a senior economist at Bloomberg, pointed out that the PMI data shows the eurozone economy improved at the start of the third quarter against a backdrop of lower commodity prices. However, the subsequent rebound in oil and gas prices could interrupt this trend. He suggested that a more sustainable recovery would be more likely only if energy costs decline in the second half of this year.
Structural pressures persist, weighing on recovery prospects for France and Germany
Despite the short-term data improvement, both of the eurozone's largest economies continue to face structural challenges, and the foundation for recovery has not yet been solidified.
The German government and the Bundesbank have both downgraded their economic growth forecast for this year to 0.5%, with growth primarily reliant on public infrastructure and defence spending. Chancellor Merz recently introduced a series of measures to boost investor confidence, and the Ifo business climate index saw a slight uptick in June. However, whether his proposed "year of growth" in 2026 can be achieved remains dependent on geopolitical developments.
The French economy, meanwhile, continues to be affected by high oil prices and weak consumption. Household consumption, a key driver of economic growth, is shrinking persistently, and consumer confidence indicators have declined markedly. The government has revised its 2026 economic growth forecast down from 0.9% to 0.7% and has acknowledged that this year's budget deficit reduction targets will be difficult to meet.
Furthermore, with the presidential election approaching next year, strained relations between the government and parliament, and the cabinet facing multiple no-confidence votes, political uncertainty is further dampening business and household confidence.
Summing up, S&P Global Market Intelligence's chief economist Williamson described the July data as showing a "welcome recovery" in eurozone economic activity. However, he added that "the volatile geopolitical environment means it remains to be seen whether this good news can be sustained." With rising oil prices and increasing shipping risks, the eurozone economy could come under renewed pressure if inflationary pressures intensify or energy supplies are disrupted.
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