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Euro Rises as Euro-Area PMIs Hint at Soft Landing, Prices Ease

Euro Rises 0.5% as May PMI Data Shows Economic Recovery and Easing Inflation in Euro Area

By Athena Xu

5/23, 04:23 EDT
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Key Takeaway

  • The euro appreciated against the dollar on May PMI data, suggesting economic recovery and potential ECB rate cuts before the Fed.
  • German PMI data exceeded expectations, indicating economic expansion and easing price pressures, aligning with ECB's objectives for rate cuts.
  • Despite a 12% YoY decline in DAX Q1 earnings, strong performances in financials and tech sectors boost investor confidence amid an improving economic outlook.

Euro Rises on PMI Data

The euro appreciated against the dollar following the release of May PMI data, which indicated that the euro area's economic recovery is gaining momentum. The S&P Global report highlighted that both input costs and output prices saw a reduction in their rates of inflation from April. A slower increase in services charges was partially offset by a weaker reduction in manufacturing selling prices.

The common currency, although at its day’s high, is trading off this week’s lows. This data supports the notion that the European Central Bank (ECB) may cut interest rates before the Federal Reserve (Fed). While an initial rate cut could weigh on the euro, there is an argument for the currency holding its ground against the dollar as markets anticipate both central banks' easing efforts to continue through 2025. Piotr Matys, a senior FX analyst at InTouch Capital Markets, commented, “The euro may extend its recent gains versus the dollar should the euro-area economy show more signs of recovery at the time when cracks on US exceptionalism may widen further in the coming months.”

German Economic Momentum

Recent Purchasing Managers' Index (PMI) data indicates that the German economy is showing signs of momentum. According to S&P Global, businesses in Germany have raised output prices at the slowest rate since early 2021, reflecting a cooling of input cost inflation. Both manufacturing and services PMI for May exceeded expectations, suggesting economic expansion in the second quarter. Average output prices were also reported to be below the long-run trend, which is a positive sign for the economy.

This development is particularly noteworthy as it comes at a time when the ECB is considering cutting interest rates next month. The easing of price pressures, combined with improved economic activity, aligns with the ECB's objectives. Analysts noted, "These are the type of reports the ECB would like to see," as they provide a conducive environment for potential rate cuts.

Wage Growth and ECB Path

Today's trading in the euro zone is expected to be dominated by data on purchasing manufacturers' indexes and negotiated wages. According to Bloomberg, unless there are unexpectedly poor readings from the activity data, traders should be cautious about pricing in additional loosening from the ECB. The provisional manufacturing, services, and composite prints for May are forecasted to show modest improvements, consistent with expectations for economic expansion in the second quarter.

However, wage growth data for the first quarter is likely to take precedence over PMI readings. The ECB's rate trajectory is significantly influenced by wage negotiations. If wage growth remains as sticky as it was in the fourth quarter, with a 4.5% reading, there would be little incentive for the ECB to cut its policy rate significantly beyond the anticipated reduction in June. Bloomberg Economics estimates the wage growth rate will be 4.3%.

Inputs from other developed markets also point to higher interest rates, which will not be lost on the ECB's governing council. Federal Reserve officials have indicated the need for several more months of good inflation data before considering rate cuts, while the Bank of England is facing higher-than-expected inflation, leading to a repricing of rate cut expectations.

German Stocks and Earnings

German stocks are expected to benefit from an improving economic backdrop, despite some headwinds. According to Deutsche Bank data, DAX first-quarter earnings fell by 12% year-over-year, mainly due to declines in industrials and autos. However, the earnings season also saw strong performances in various industries and positive outlooks. Financials were the biggest positive earnings driver, with Commerzbank upgrading its lending income outlook. Chipmaker Infineon reported positive developments in China and Europe's electric vehicle markets, while Siemens Energy saw a rally due to a turnaround in its wind unit and job cuts.

The improving economic outlook and potential ECB interest rate cuts are expected to boost German stocks further. Investor confidence in Germany has risen, and the services sector is showing signs of improvement, although manufacturing remains soft. Recovery in the Chinese economy is also expected to provide support. Consensus forecasts suggest the DAX could achieve double-digit profit growth in the second half of 2024, with Deutsche Bank projecting 5% earnings growth for both the DAX and Stoxx 600 in 2024.

Street Views

  • Piotr Matys, InTouch Capital Markets (Bullish on the euro):

    "The euro may extend its recent gains versus the dollar should the euro-area economy show more signs of recovery at the time when cracks on US exceptionalism may widen further in the coming months."