Better than expected growth

The most recent growth indicators have surprised positively in the euro area. The October PMIs exceeded expectations, with the composite PMI rising to 52.2, its highest level since May 2023, supported by a strengthening services sector at 52.6. Notably, Germany's service sector demonstrated robust recovery, achieving two consecutive months of growth and reaching 54.5. This sustained improvement points to a better growth momentum than we previously expected. Meanwhile, the manufacturing PMI also surprised positively, improving slightly to 50.0 from 49.8, moving the sector out of contraction territory. However, the manufacturing recovery remains fragile, with export orders declining for the fourth consecutive month, weighing on overall demand for European goods amid a strengthened euro. Yet, as energy costs have come down and previous monetary policy easing is still transmitting into the sector, we expect that manufacturing activity has bottomed out. 

GDP growth in Q3 also surprised positively, rising to 0.2% q/q, exceeding the ECB's expectation of 0.0% q/q. Although detailed growth drivers are not yet available, exports played a key role, particularly in France, which recorded a strong 0.5% q/q expansion, outperforming expectations. This was driven by an unexpected surge in exports, despite weaker PMIs during the same period. Meanwhile, in Spain, robust domestic demand underpinned growth, as Q3 GDP rose 0.6% q/q, supported by strong employment growth. Looking ahead, we expect the euro area economy to grow at a similar pace in the final quarter of the year as in Q3, since October PMIs point to continued momentum.

Headline inflation in the euro area eased to 2.1% y/y in October, down from 2.2% in September as expected. Core inflation, however, remained steady at 2.4% y/y, slightly above expectations. The decline in headline inflation was thus primarily driven by lower energy and food price inflation, with food inflation falling to 2.5% y/y from 3.0% in September. Service inflation remains strong, with prices rising around 0.40% m/m in seasonally adjusted terms. On an annual basis, service inflation rose to 3.4% y/y in October, highlighting its persistent stickiness. This is likely due to wage growth still being rather robust (see chart). We got the first data on Q3 wages from Spain, where wage growth increased to 4.1% y/y from 3.9% in Q2 signalling that euro area wage growth also was sticky in the third quarter. The robust wage growth is expected to sustain elevated service inflation in the coming months. 

The ECB kept its policy rates unchanged at the October meeting, with the deposit facility rate at 2.00%, as expected. Better than expected growth support the view that current rates are "in a good place." The inflation outlook remains broadly unchanged, and no new guidance was provided by Lagarde at the meeting leaving markets unaffected. President Lagarde highlighted easing of some downside growth risks, citing the US-EU trade deal, Gaza ceasefire, and improved US-China relations. We maintain our view that the ECB will keep policy rates unchanged in 2025 and 2026. For details see ECB review - Abated downside growth risks, 30 October. 

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