Inflation is back below the 2% target

Growth momentum slowed in September, with the composite PMI falling to 49.6 from 51.0 in August. The services PMI ticked lower to 51.4 from 52.9 mainly because of the Olympic games in August, which then dragged French PMIs significantly lower in September. Overall, the service sector remains in expansionary territory but it has weakened during the past quarter due to Germany and France while Spain experiences higher activity. The manufacturing sector continues to struggle, particularly in Germany due to both local problems and a global slowdown.

The labour market has moderated recently, and the PMI employment index dipped below 50 for second month in a row (49.7 in September). The employment situation has particularly moderated in Germany and France, whereas employment growth continues to be decent in Spain, Portugal and Greece. For details, see Research euro area - Moderating labour market with downside risks, 3 October.

Inflation fell below 2% for the first time in three years to 1.8% y/y in September, as expected. The decline was mainly due to energy inflation while core inflation was stickier at 2.7% y/y (prior: 2.8%) due to high services inflation at 4.0% y/y and low goods inflation at 0.4% y/y. Importantly, momentum in services inflation declined significantly as service prices rose only 0.14% m/m s.a., which was the lowest monthly rate this year. Headline inflation has averaged 2.17% in Q3, below the expectation of 2.3% in the latest ECB projections. Combined with easing services momentum this should make the ECB more confident of inflation returning persistently to target.

As inflation has declined more than expected, the labour market is moderating, and the near-term growth outlook is weak, we have adjusted our ECB profile, now expecting an October rate cut of 25bp, and a December 2025 rate cut. Our new outlook consists of two cuts for the remainder of 2024, and four quarterly cuts next year, bringing the deposit rate to 2% in December 2025. For more details, please see COTW: October rate cute is the baseline – Why wait?, 27 September.

In France, the new Prime Minister, Michel Barnier, has formed his government, mainly from Macron's centrist alliance and his own conservatives, aiming for crossparty support in a fragmented parliament. Tackling France’s strained finances is a top priority, but no easy task with the country facing an excessive deficit procedure by the EU. To address this, Barnier’s government has proposed a €60bn budget squeeze for 2025 to curb the deficit, which is expected to reach 6.1% of GDP this year. The plan aims to reduce the deficit to 5% by year-end 2025 but only meet the EU's 3% target by 2029. Large budget deficits and likely confrontations with the EU has made investors demanding a premium for investing in French debt. In September, we saw French 10-year government yields ticking higher than Spanish for the first time since 2007 – also driven by the much more upbeat growth story and public finances in Southern Europe. For details, see Research euro area - Southern Europe to continue outperforming, 23 September.

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