Monex Europe: Eurozone services PMIs underscore the need for more ECB hikes

Monex Europe: Eurozone services PMIs underscore the need for more ECB hikes

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Markets have recently adjusted to the idea that the eurozone economy isn’t diverging as much from the US as previously thought, eurozone growth is now seen cooling and expectations of a US recession have been tempered.

This has recently been highlighted by the decline in confidence indices and measures of industrial output within continental Europe.

However, one area of divergence remains in the form of monetary policy, with the ECB still seen to be hiking over the summer months while the Fed is more likely than not to take a pause over this period.

It is against this backdrop that today’s flash PMIs out of France, Germany, and the eurozone as a whole are viewed. Of specific focus is the services sector, and for two reasons.

Firstly, the eurozone’s manufacturing sector has long been in contraction since its boom over the pandemic years, and thus the pace of expansion in services activity is crucial for overall GDP estimates.

Secondly, core services inflation is yet to rollover unlike core goods inflation. This was highlighted as recently as yesterday by the ECB Chief Economist, Philip Lane.

Therefore, strength in the eurozone service sector, in terms of output, employment, and prices paid are crucial for determining the ECB’s tightening path and its terminal level.

With the exception of France’s overall level of output, May’s flash PMIs showed resilience within service sector activity, which translated into continued employment and output price growth in services.

This will come as a concern for ECB policymakers and validates the message that has been wholeheartedly relayed by policymakers since the May 5th meeting. That is, although interest rates are close to the terminal level, further tightening of monetary policy is required.

While markets have been somewhat hesitant to buy into the guidance, we are now seeing money market pricing align with our view that two further rate hikes are likely. This would bring the deposit rate to a terminal level of 3.75%.

With market pricing already stable around this view ahead of today’s PMIs, the data had more of an impact further out on the curve with fewer rate cuts priced in 2024 as a response. This has led to an uptick in front-end eurozone yields, which has supported the euro against what is a broadly stronger dollar this morning.

With growth momentum proving somewhat resilient and core services inflation likely rising, today’s data underscores the need for the ECB to do more.