September PMIs confirmed the contractionary trend we have seen in recent months, with the composite PMI coming at 47.1, despite a slight increase from the August 33-month low (46.7). The continued drag mostly attributes to the manufacturing sector where PMIs declined to 43.4, whereas the service PMI surprisingly edged higher to 48.4 from 47.9 in August – though remaining in contractionary territory. The readings suggest that the euro area economy is cooling at a pace that is still comfortable for the ECB as inflation is coming down and the unemployment rate remains at historic lows of 6.4%. We still have the ‘soft landing’ as our base case and believe that the pace of the current slowdown will prevail in the coming months due to persisting monetary headwinds and waning demand. Yet, the risk is still that we suddenly will see a sharp contraction if energy prices increase sharply over the winter and financial conditions quickly tightens.
Headline inflation posted a 2-year low in September cooling to 4.3% y/y from 5.2% y/y in August, while core inflation printed at 4.5% compared to 5.3% in August. The upbeat prints are mostly attributed to fading base effects from various government subsidies provided last year affecting both energy and core services inflation. Still, the month-on-month change in inflation also declined in September and shows encouraging signs especially in core inflation. The underlying price pressure still persists but the trend is clearly declining in line with signals from PMI output prices. That said, it is still too early to declare victory over inflation. Input prices within the service sector picked up for the second consecutive month due to continued wage increases. Further wage increases from the strong labour market, higher than expected energy prices, and the risk of food price increases from the upcoming ‘El Niño’ provides upside risks to the inflation outlook.
In line with our call, the ECB delivered a 25bp hike at the September meeting, while also indicating that the hiking cycle is on pause for now. Generally, our main conclusion of the meeting was that the ECB now plans on maintaining policy rates at current levels for some time instead of continuing to hike policy rates. The ECB’s staff inflation projections was revised higher for 2023 and 2024 but lower for 2025. For core inflation, the projection is now slightly lower across the board – see Flash ECB Review, 14 September. With regards to the October meeting, we believe that the ECB has concluded its hiking cycle (deposit rate of 4.00%) – in lieu we expect the ECB to task committees to look into an advancement of the end date to full PEPP reinvestments.
As populist parties are gaining increasingly political support within Europe, the Polish national election on October 15th will be key to follow. The recent election in Slovakia is the latest example of this movement, with Robert Fico’s populist Smer party winning 22.9% of the votes. Fico has publicly advocated for an end of Slovakia’s support to Ukraine and a change in the EU’s direction. In Poland, a potential third term for the ruling nationalist party Law and Justice (PiS) could support the nationalistic rise in Europe given the party’s interest in shifting EU’s course. Opinion polls suggest that PiS could win the vote but may struggle to form a majority. With the Smer party’s win in Slovakia and PiS potentially winning the Polish elections a nationalistic block with the two countries and Viktor Orban’s Hungary could complicate decision-making within the EU on support for Ukraine amongst other things.
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