Euro area – Rebounding service PMIs give some relief

December PMI provided relief by partially rebounding from the significant decline in November. The composite PMI rose to 49.6 (prior: 48.3, cons: 48.4), driven by a larger-than-expected bounce back in services, which increased to 51.6 from 49.5, bringing services PMI back to the same level as in October. In contrast, the manufacturing PMI remained almost unchanged at 45.1 (prior: 45.2), highlighting that services continue to compensate for the declining activity in the industry. The contraction implied by PMIs in December thus returned to be entirely manufacturing-led, with France and Germany performing the weakest. German weakness was also visible in the Ifo index which fell to 84.7 in December from 85.7, a larger drop than anticipated, mainly driven by lower expectations for the economy, indicating a continuously deteriorating economic situation. Spain, however, continue to show strong PMIs with continued expansions in economic activity. The December PMI rebound offers some relief for the growth outlook. Still, with the average composite PMI lower than in Q3, the data supports our view of an economic contraction in Q4 with GDP growth at -0.1% q/q, pulled down by the industry.  

Headline inflation rose to 2.4% y/y (0.3% m/m s.a.) in December, as expected, up from 2.2% in November. This increase was mainly driven by energy base effects, while core inflation remained unchanged at 2.7% y/y. Core services showed monthly price increases on the high side with 0.3% m/m s.a., however, this comes after a very low print in November, so 3m/3m momentum continued lower in a positive sign for the ECB. Moreover, December's inflation figures resulted in Q4 average inflation 10bp lower than ECB staff predictions. Hence, December's data confirmed the narrative of weakening momentum in underlying inflation as momentum in services is coming lower while goods remain very low. Following the uptick inflation in 2024, we expect headline inflation to decline in 2025 Q1, averaging 2.1% as base effects reverse. 

The ECB concluded 2024 by cutting its policy rate by 25bp, aligning with market expectations. Most importantly, the ECB removed the pledge to keep monetary policy restrictive, now indicating that they will use the three-tiered reaction function inputs as key metrics (inflation outlook, underlying inflation and strength of monetary policy transmission) to set its policy rates - see Flash: ECB review, 12 December. Looking ahead we still expect the ECB will cut its policy rate by 25 bp six times in 2025 as the disinflationary process remains on track.

The ECB faces ongoing uncertainty regarding the labour market as survey indicators have significantly softened in previous months. Unemployment expectations in the consumer survey jumped to a two-year high in December, and the indicator has previously leaded changes in the unemployment rate. However, hard data continues to show a solid labour market with rising employment in Q3 and the unemployment rate remaining at record-low of 6.3% in November. Hence, the labour market remains very strong but forward-looking soft indicators point to risks of a deterioration.

Download The Full Research Euro Area