Despite pressures from inflation and weakened confidence stemming from the Middle East conflict, the contraction in Eurozone business activity in June was less severe than anticipated, bolstering optimism that the region's economy can withstand the shocks.
Data released on Tuesday showed the composite Purchasing Managers' Index (PMI) rose to 49.5 in June from 48.5 in May, surpassing analyst expectations of 49.2. While this marks the third consecutive month the index has remained below the 50 threshold that separates growth from contraction, the improvement signals resilience.
Breaking down the figures, the Eurozone's manufacturing PMI edged down slightly to 51.3 from 51.6, while the services PMI improved to 48.9 from 47.7.
Private Sector Contraction Less Severe Than Forecast
The composite PMI readings for the Eurozone's two largest economies both remained below 50 in June but painted contrasting pictures. Germany's PMI declined further to 48.0 from 48.8, missing the market forecast of 49.6. Its manufacturing PMI fell to 50.0 from 51.1, and the services PMI dropped to 46.8 from 48.1.
In contrast, France's PMI rebounded to 47.6, outperforming May's 44.9 and the expected 46.4. The manufacturing PMI rose to 50.7, and the services PMI improved to 47.4.
The chief business economist at S&P Global Market Intelligence noted that the Eurozone economy has demonstrated sufficient resilience to narrowly avoid a recession, adding that the modest decline in activity suggests second-quarter GDP is likely to be largely flat.
After a period of robust growth earlier this year, the Eurozone is increasingly burdened by high energy costs and uncertainty from the Middle East situation. While efforts toward a lasting peace have boosted optimism, doubts persist, and the recovery of European market confidence will take time.
Data indicates the contraction in Eurozone services activity narrowed in June. Sectors related to tourism and leisure reported a gradual recovery in demand following the initial shock of the conflict. Meanwhile, manufacturing continues to benefit from inventory building as clients, fearing supply risks, make advance purchases to hedge against future price increases.
Adding to economic pressures, the European Central Bank implemented its first interest rate hike since 2023 this month, warning that inflationary pressures from the conflict are spreading from the energy sector more broadly. Recent data showed underlying inflation pressures in May were stronger than initially reported, raising the likelihood of further ECB rate hikes.
The ECB's chief economist warned that inflationary pressures from the Middle East conflict have not yet fully passed through to the economy, and the central bank must be prepared for inflation to remain above target for some time. Several ECB Governing Council members have echoed concerns, suggesting monetary policy could be tightened further.
Market participants and economists widely expect the ECB to implement at least one more 25-basis-point rate hike, bringing the deposit facility rate to 2.5%. Eurozone inflation is anticipated to remain significantly above the ECB's 2% target in the near term.
This inflation concern is reflected in the ECB's latest quarterly economic projections, which show headline inflation reaching 3.0% in 2026, higher than the 2.6% forecast in March. Core inflation, excluding food and energy, is projected to be 2.5% in 2026, also higher than the previous forecast.
Simultaneously, the ECB downgraded its GDP growth forecasts for the current and coming years, highlighting the central bank's dilemma of persistently high inflation alongside a weakening growth outlook.
The ECB President recently reiterated the need for policy flexibility but stated current data is insufficient to warrant a more forceful policy response. Some easing in price pressures suggests the recent inflation surge may be nearing its peak, potentially supporting a more dovish policy stance.
According to S&P data, while input costs for Eurozone firms continued to rise rapidly in June, the pace of increase slowed to its lowest since February. Output price inflation also moderated, though by a smaller degree than input costs. Supply chain delays remain widespread and continue to exert upward price pressure, but there are initial signs of easing concerns regarding supply and price trends.
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