Euro-Area Business Activity Surges to One-Year High, ECB Optimistic on Economic Recovery

Key Takeaway

• Euro-area business activity hit a one-year high in May with PMI rising to 52.3, signaling robust economic recovery.
• Germany's PMI rose to 52.2, showing strong private-sector growth, while France's services sector underperformed.
• ECB is optimistic about achieving price stability without recession; inflation nearing 2% target may lead to rate cuts.

Euro-Area Business Activity Surge

Euro-area private-sector business activity has reached its highest level in a year, indicating a robust economic rebound. According to S&P Global’s purchasing managers’ index (PMI), the index rose to 52.3 in May, surpassing analyst forecasts and remaining above the 50 threshold that signals growth for the third consecutive month. This positive development suggests that the region's economic recovery is gaining momentum.

Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, commented on the situation, stating, "This looks as good as it could be. The euro zone’s economy is gathering further strength. Encouragingly, new orders are growing at a healthy rate while the companies’ confidence is reflected by a steady hiring pace." This sentiment is echoed by the performance of Germany, Europe’s largest economy, which also exceeded expectations with a notable contribution from manufacturing. However, France experienced a setback, with its composite gauge unexpectedly dipping back below 50 due to underperformance in the services sector.

Despite the mixed performance between Germany and France, de la Rubia remains optimistic, noting, "While people love to compare the performance of economies, finger-pointing to the possible weaknesses and strengths, the good news here is that overall, both economies move in tandem. This means that there are good chances for France to catch up eventually in the services sector, which would put euro-zone growth on a sounder footing."

Economic Outlook and ECB Policies

The outlook for the 20-nation euro area is improving after a recession in the latter half of last year. With inflation nearing the European Central Bank's (ECB) 2% target and the ECB poised to begin lowering interest rates, the European Commission has indicated that the continent remains on track for a soft landing. ECB Executive Board member Isabel Schnabel expressed optimism, stating, "We’re currently seeing a slight revival of the economy in the euro area. At the same time, inflation continues to retreat. Therefore, there’s reason for hope that we’ll succeed in returning to price stability without experiencing a recession."

However, the growth masks ongoing challenges in the industrial sector, particularly in Germany, which has been affected by weak global demand and the spike in energy prices following Russia’s invasion of Ukraine. S&P Global predicts that the euro area may record a gross domestic product (GDP) growth of 0.3% this quarter, matching the pace of the previous three months.

There are also warning signs for consumer prices that could influence the speed at which the ECB reduces rates this year. S&P Global identified the services sector as the "principal source of inflationary pressure," with input costs rising rapidly. ECB Vice President Luis de Guindos cautioned that price growth might fluctuate in the short term before stabilizing at 2% by 2025. He emphasized the uncertainty surrounding future interest rate cuts, stating, "We have made no decisions on the number of interest rate cuts or on their size. We will see how economic data evolve."

German Economic Momentum

Germany's economy is showing signs of recovery, as indicated by recent PMI data. S&P Global's PMI for Germany rose to 52.2 in May, surpassing analyst expectations and remaining above the 50 threshold for the second consecutive month. This marks the fastest pace of private-sector activity growth in a year. The services sector continued to lead the advance, while the manufacturing sector, although still in contraction territory, recorded its highest reading since January.

Cyrus de la Rubia noted signs of a potential turnaround in the manufacturing sector, stating, "These numbers offer hope. Those predicting a prolonged weakness in the German economy might be proven wrong soon." Additionally, businesses in Germany raised output prices at the slowest pace since early 2021, reflecting a cooling of input cost inflation. This development aligns with the ECB's objectives and could pave the way for interest rate cuts.

Street Views

• Cyrus de la Rubia, Hamburg Commercial Bank (Bullish on the euro zone economy):

  "The euro zone’s economy is gathering further strength. Encouragingly, new orders are growing at a healthy rate while the companies’ confidence is reflected by a steady hiring pace."

• Isabel Schnabel, ECB Executive Board member (Cautiously Optimistic on the euro area economy):

  "We’re currently seeing a slight revival of the economy in the euro area. At the same time, inflation continues to retreat. Therefore, there’s reason for hope that we’ll succeed in returning to price stability without experiencing a recession."

• Luis de Guindos, ECB Vice President (Neutral on interest rate cuts and economic outlook):

  "There is a huge degree of uncertainty... We have made no decisions on the number of interest rate cuts or on their size. We will see how economic data evolve."