The European economy, largely left for dead late last year, continued to perform in February, preliminary PMIs released on Tuesday suggested.
Europe’s resilience has been billed as a miracle of sorts. Six months ago, an existential energy crisis seemed assured, and many feared some Europeans might actually freeze (to death) over the winter months.
By the end of 2022, though, the weather was favorable, the regional natural gas benchmark had given back the entirety of the war premium and government subsidies helped shield the public from the impact of price increases.
Data released in late January showed the euro-area economy managed to eke out a surprise expansion in the fourth quarter. Tuesday’s figures from S&P Global showed activity accelerating this month. The composite gauge hit a nine-month high at 52.3, up two points from January.
The manufacturing gauge moved into expansion territory for the first time since June, and the services index spent a second month above the 50 demarcation line.
“Rising demand, healing supply chains, order book backlog reduction and improved confidence underpinned the upturn,” the color accompanying the release said, calling the data “consistent with the economy expanding in the first quarter so far, with employment also continuing to rise.”
This probably sounds mundane, but it’s crucial to the macro narrative and the policy backdrop. While it’s obviously good news that Europe averted a “Dark Ages”-style winter, the better the economy performs (and particularly the services sector), the harder it’ll be for the ECB to rein in inflation.
“Business activity across the eurozone grew much faster than expected in February,” S&P Global’s chief business economist Chris Williamson said Tuesday. He noted that although faster delivery times have shifted pricing power “from suppliers to factory purchasing managers, bringing industrial price inflation down,” the services sector is another story. Williamson cited “persistent elevated price trends” in services “linked in part to higher wage growth.” That, he cautioned, “will concern ECB policymakers.”
Last year, I argued (correctly) that inflation in Europe was largely beyond the ECB’s capacity to control given that price growth was influenced so heavily by war-related volatility in energy and food costs. In 2023, by contrast, inflation looks to have migrated into services sector wage-setting. It’s a cautionary tale about the extent to which inflation, whatever the initial cause, can become an economy-wide phenomenon if it persists for too long.
“The combination of better-than-expected economic activity at the start of the year and service sector inflationary pressures will likely keep the ECB in hawkish mode,” ING’s Bert Colijn said.
On Monday, following hawkish commentary from Isabel Schnabel, Goldman added a hike to their house ECB call. “Together with our above consensus growth forecast and our updated expectation for a 5.25-5.5% peak Fed funds rate, we now see a further 25bps hike in June and raise our forecast for the [ECB] terminal deposit rate to 3.5%,” the bank’s Sven Jari Stehn and Alexandre Stott wrote.
If Goldman’s call is borne out, it’d mean the ECB would’ve hiked 400bps out of negative territory in just 11 months.
In the interview Goldman cited, Schnabel said, “We are still far away from claiming victory on inflation. A broad disinflation process has not even started in the euro area.”
Oh, and do note: Europe’s successful avoidance of a worst-case consumer crunch came at a very steep cost+.
