Growth resilience takes rate cuts off the table in 2027
Economic activity has proved more resilient than expected over the summer despite negative supply shocks from higher energy prices linked to the war in Iran and unusually warm weather. Euro area GDP rose by 0.4% q/q in Q2, up from flat growth in Q1 and well above expectations. The August PMIs suggest that solid growth momentum continued into Q3, with the composite PMI edging up to 52.1 from 52.0 in July, surprising to the upside. The improvement is still mainly driven by manufacturing, with the PMI rising to 52.7 from 51.9, supported by higher output and new orders. Indirect AI-related investment demand seems to be supporting, as firms in the euro area supply equipment and infrastructure for data centres and power systems. Fiscal policy is also turning more supportive, particularly through higher German public spending and less tightening in France than we expected. The services PMI was unchanged at 51.7 but still came in above expectations, with weakness in Germany and France offset by firmer activity in Southern Europe. Overall, the August PMIs point to rather solid Q3 growth around potential despite the recent shocks.
Euro area HICP inflation rose as expected in August to 3.3% y/y, from 2.9% y/y in July, while core inflation declined to 2.4% y/y, below expectations of 2.5%. The rise in headline inflation was entirely driven by energy prices, with food inflation unchanged and core inflation lower. Momentum in core inflation remains low, with few signs of energy prices spilling over to underlying inflation. Core inflation rose around 0.17% m/m s.a., taking the 3m/3m SAAR (which measures current annualised momentum) down to 2.6% from 2.7%. The loss of momentum was due to services momentum fading to just 0.1% m/m s.a., while goods momentum is slowly ticking higher from a very low starting point. Broader non-energy inflation momentum is also running close to 2%, pointing to contained underlying inflation.
The combination of growth around potential and contained underlying inflation has led us to revise our ECB call (see Research Euro Area: New ECB call – No cuts in 2027, 27 August). We continue to expect a final 25bp hike in September, taking the deposit rate to 2.50%, but now see the ECB keeping it there throughout 2027 rather than cut it back to 2.00%. The more resilient growth backdrop removes the need for cuts next year, while contained underlying inflation limits the need for more than one additional hike. With the deposit rate at 2.50% from September and onwards, policy will be at the upper end of the ECB’s estimated neutral range. Further hikes would take policy into restrictive territory, which we do not think the inflation data justifies given the absence of energy-related spillovers to underlying inflation. Risks to our call are balanced, with stronger spillovers or low gas inventories posing upside risks, while slower wage growth or a weakening labour market could still lead to cuts before the end of 2027.
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.
