Euro area: Growth to continue, despite a decline in PMIs

In contrast to the strong data releases in previous months, June PMIs declined unexpectedly with the composite indicator falling to 50.8 from 52.5 in May, below expectations of 52.5. The decline was broad-based with both manufacturing and services ticking lower. A combination of waning new orders, business confidence and employment drove down manufacturing.

Despite, the downtick, the composite PMI was significantly higher in Q2 compared to Q1, indicating that the economy also grew in Q2. Yet, the decline in June raises questions about the strength of future growth. We believe the drop was likely a correction to the stronger than expected data in April and May and focus more on the last quarter as an average. Hence, we expect the economy to continue growing, driven by a strong services sector, resilient labour market and rising real incomes. Moreover, the manufacturing sector is still expected to improve as the worst is over but the rebound seems more fragile amid the weakening new orders.

Headline inflation in June declined to 2.5% y/y from 2.6% y/y due to lower energy and food inflation, while core remained sticky at 2.9% y/y. Decomposing the print reveals a continued strong momentum in services inflation. However, using the ECB’s own seasonally adjusted data signals that services inflation, and thus core inflation crept slightly lower on a monthly basis, giving some relief to the ECB. That said, and akin to the picture seen lately, underlying inflation momentum – especially services inflation – remains too high for the ECB’s comfort. As the labour market remains strong, with the unemployment at record low of 6.4% in May, a prolonged period of elevated services inflation poses a key upside risk to inflation.

Le Pen’s National Rally (NR) led the first round of the French election, clinching 33.2% of the votes. The left-wing New Popular Front (NPF) came second with 28.0% ahead of President Macron’s centrist alliance (Ensemble) (22.4%). The results suggest that NR will have the most seats in the 577-seat National Assembly, and they could win an absolute majority (289 seats). However, we believe the most probable outcome is that no party will gain an absolute majority, resulting in a ‘hung parliament’ and policy gridlock. Hence, France’s public spending, which has been a centre of attention in recent weeks, is not set to rise markedly. For more details, see Flash: French election – Public spending is not set to rise significantly, 1 July. 

Lately, France's fiscal situation has had a greater impact on financial markets. S&P downgraded the country’s credit rating due to concerns over its debt situation in May. Additionally, in mid-June, the European Commission (EC), proposed to place France, along with seven other nations, in the Excessive Deficit Procedure (EDP) for exceeding the bloc’s deficit threshold. As of 2023, France’s debt-to-GDP and public deficit levels stood at 110.6% and –5.5%, respectively. That said, the crunch point for the EDP is still far off. The warranted countries have several months to present proposals on how to improve public finances to the EC, after which a larger political process will begin. We do not expect the EC’s rebuke of France to escalate for now, as France is likely to work with the EC in both the case of a ‘hung parliament’ and an absolute majority for the National Rally.

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