The Euro area economy starts 2024 on a firm footing

The euro area economy has been off to a good start in 2024, with Q1 GDP exceeding expectations at 0.3% q/q (cons: 0.1% q/q, prior: -0.1% q/q). The uptick was mostly buoyed by Spain where GDP rose 0.7% q/q while Germany saw activity rising 0.2% q/q. National GDP sources reveal that growth largely attributed to increasing foreign demand. Coupled with the pessimistic consumer confidence and weak retail sales suggests that domestic demand continues to remain relatively muted. That said, we foresee domestic demand to pick up during the year as rising real incomes and a strong labour market will support household consumption. This view was underscored by the continued low unemployment at 6.5% rate in March. The number of unemployed persons even declined by 0.85% compared to February.

The narrative of a better-than-expected start in 2024 was further underscored by the April composite PMI surprising to the upside at 51.4 (cons: 50.7), remaining above 50 for the second consecutive month. Decomposing the measure, signals that the economy continues to drive in two speeds. The services PMI was higher-thanexpected at 52.9, whereas the manufacturing counterpart edged down to 45.7. Subindices indicate that employment ticked higher, mainly within the services sector boding well for domestic demand, but at the same time increasing risks of even more sticky service inflation due to pressures on wage growth from the tight labour market.

Notably, Germany entered growth territory for the first time since June last year as the composite PMI climbed to 50.5. The upward move was spurred by a strong services sector, while manufacturing was still struggling. Overall, we believe that the worst is over in manufacturing sector and it will gradually muddle through going forward – for more detail please see Research Germany – Worst is over in German manufacturing sector, 16 April.

Headline inflation in April stood unchanged at 2.4% y/y, whereas the core measure surprised marginally to the upside, creeping up to 2.7% y/y (cons: 2.6%). The release confirms the overall picture seen in recent months with especially the momentum in services inflation to the high side. Services inflation came out at 0.3% m/m SA in April following a 0.50% m/m increase in March. In tandem with an increase in the PMI services price index the sticky services inflation poses a significant upside risk to the inflation and ECB policy rate outlook, especially with the economic slowly gaining speed again. The ECB essentially controls domestic demand, which ultimately drives service inflation and wage growth.

Despite recent data releases, in particular the sticky inflation momentum and sound start of growth in 2024, being non-supportive of a rate cut in June, we expect the ECB to deliver one of 25bp. The ECB has basically outright guided for a June cut coupled with historical data corroborating that the ECB rarely has surprised markets by changing its stance. Additionally, the policy rate is at a historically restrictive level. However, we acknowledge that since early March the balance of risks has strongly pointed towards fewer than three cuts this year.

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