Easing price pressures open door for dovish ECB
Economic activity showed tentative signs of stabilising in June following the US-Iran deal and subsequent drop in energy prices. The composite PMI rose to 49.5 from 48.5 in May, surprising to the upside as services recovered to 48.9. The rebound was broad-based, with France improving strongly, although from a low level, and Southern Europe also improving. This more than offset continued weakness in Germany, where the services PMI fell to 46.8 – the lowest since 2022. The German Ifo report, however, indicated that the services PMI may have understated actual growth, as the current situation assessment in services is now back above pre-war levels. Euro area manufacturing PMI eased marginally to 51.4 due to shorter delivery times, but both new orders, employment and output all rose in a more positive sign.
Euro area HICP inflation declined more than expected in June to 2.8% y/y, with most economies surprising to the downside. The decline was also broad-based across energy, food and core inflation. Core inflation fell to 2.4% y/y, driven by services falling from 3.5% y/y to 3.2% y/y. Services momentum eased to around 0.2% m/m s.a., following the strong rises seen in recent months. Inflation in Q2 has now averaged 3.0% y/y – below the ECB's latest projections of 3.2% y/y across all their scenarios. Food prices continued to fall in June, and goods price momentum remains low, meaning that the indirect effects from the energy shock are so-far very limited, which is dovish for the ECB.
Forward-looking indicators should also give the ECB some relief. PMI price indices declined in June, led by services, where the output price index returned to prewar levels, while manufacturing price indices remained elevated. The EC’s business survey confirmed this, with selling price expectations falling across all sectors from April peaks, although they remain elevated in the industry and retail sector. The EC’s survey also revealed that firms' employment expectations declined further across retail trade, services and construction. The weakening labour market reduces workers' bargaining power, limiting the risk of secondround effects through wage increases.
These dynamics are increasingly weighing on the ECB's outlook. At its June meeting, the ECB hiked policy rates by 25bp, bringing the deposit rate to 2.25%, with President Lagarde downplaying growth risks and emphasising upside inflation risks. Since then, oil prices have collapsed following a US-Iran peace deal, with spot oil trading below the ECB's 'milder' scenario. Market-based inflation expectations have also declined, with 2y2y at 2.00% and 1y1y at 2.20%. Whilst we still forecast a 25bp hike in September, we see clear downside risks to the call.
Author
Danske Research Team
Danske Bank A/S
Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.
