Positive developments in hard data amid tariff chaos

The euro area economy continues to show signs of normalization, with PMIs rising and inflation declining. The composite PMI marked its third consecutive monthly expansion in business activity, as the index rose to 50.9, above the anticipated 50.7. This increase marked the highest level since August 2024, signalling the quickest growth rate in seven months. Both services and manufacturing contributed to March’s accelerated economic upturn, with manufacturing PMI notably improving in 2025Q1, climbing from 42.1 in December 2024 to 48.6 in March 2025, approaching growth territory. With composite PMI consistently above 50 throughout 2025Q1, the euro area economy likely grew around 0.3% q/q, which is slightly more than expected by the ECB and consensus.

As with PMIs, inflation in the euro area is also normalizing and closing in on the 2% target quicker than expected in March. Headline inflation fell to 2.2% y/y, down from 2.3% in February, driven by lower energy and services inflation. This aligns with the latest ECB staff projections of an average 2.3% y/y inflation rate in Q1. Services inflation decreased to 3.4% y/y from 3.7%, which is encouraging, although the elevated growth rate remains a concern for the hawk camp in the ECB. Yet, with lower momentum and declining wage growth, we expect services inflation to continue to decline this year. By 2025Q2, we expect headline inflation to average 2.2% y/y in line with the ECB staff projections and inflation markets pricing. In our opinion these developments support further easing from the ECB.

Markets have increased its’ rate cut expectations for the ECB this year, with a 25bp cut in April now fully priced in and a 2025 end point of 1.65%. The recent increase in rate cut expectations comes on back of the tariff announcements of Trump and not macro data as the latter have been surprising positively. In addition to the mentioned PMIs, the unemployment rate reached an all-time low of 6.1% in February and credit growth continued to increase. The strong labour market is especially driven by Southern Europe, while French unemployment continues to rise, and the PMIs signals further deterioration to come.

The positive macro developments are overshadowed by concerns about the growth outlook from a global trade war and a following recession in the US. These concerns were ignited by Trump’s announcement of a 20% tariff increase on all EU goods imported to the US, except pharmaceuticals, while steel, aluminium, and cars face a 25% tariff. The tariffs threaten EU’s exports to the US, which in 2024 amounted to EUR532bn, corresponding to 3% of EU GDP. Using estimates from the ECBGLOBAL 2.0 model, we estimate that the increase in tariffs will shave off 0.2-0.4pp of euro area GDP in the coming year, assuming that recent tariffs are held unchanged in the entire period on all countries in the world and there is retaliation. The EU is expected to hit back to the general 20% US tariff increase and the 25% car tariffs in the start of May if negotiations in the meantime fail with the US, which we expect they will. EU will likely target both goods and services by both tariff and non-tariff measures to pressure US. The outcome of the trade war is highly uncertain, and risks are tilted towards a larger negative impact.

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