With PMI near 12-year high, Draghi can be more hawkish

The composite services and manufacturing activity gauges across the set of the Eurozone counties paint a very rosy picture of Eurozone’s economic recovery. While manufacturing peaked in November and December last year, the services are picking up in the beginning of 2018, pushing the composite indices higher. Actually, for the Eurozone, the composite PMI is at the highest level since June 2006, when ECB marginal lending facility rate was 3.75% and the deposit rate was 1.75%. With the activity back at the cyclical high, the post-2009 economic crisis story is different. The ECB’s deposit rate is negative at -0.40% and the marginal lending facility stands at 0.25%, but the banks do not borrow from ECB, because the liquidity is so ample that the deposit rate has to be negative to motivate them to lend to the real economy instead of parking the money with the ECB.

The asset purchasing program has just been cut into half with the ECB buying only 30 billion monthly from January this year, and should the economic indicators remain positive, we should see some clear forward guidance on interest rates soon from Mario Draghi after the asset purchasing will presumably end in September this year. Economic conditions are good and the unemployment is also at the decade low of 8.7% in the Eurozone. The main message from the PMI report is the one of the inflation. In countries like Spain and more importantly in Germany, the signs of inflation pressures are reappearing and should those be confirmed, the time is short before the market will hear the key messages regarding interest rates from the policymakers at the ECB. It won’t take Draghi long before he makes it clear that the economy is finally out of the woods post-2009 crisis.

Following are the key messages from the composite PMI reading for countries of the Eurozone:

Spain
Services PMI rose to 56.9 in January with a steep rise in activity the fastest since July 2017. Companies were able to take advantage of further improvements in the economic environment to secure greater volumes of new business. One other noteworthy aspect of the latest set of PMI results was a pick-up in inflationary pressures. Companies were able to increase their selling prices at the fastest pace in almost 11 years as client demand strengthened.

Italy
Italian services PMI at 57.7 in January, optimism reaches the highest level since May 2011. Taking both the manufacturing and service sectors together, combined output rose to the strongest degree since June 2006 and was consistent with GDP rising at a rate of around 0.6% q/q at the start of the year. 

France
Service PMI rose to at 59.2 in January and the composite PMI posted 59.6 in January, unchanged from the previous month and down only slightly from November’s six-and-a-half year high of 60.3, indicating one of the sharpest rounds of monthly growth since early-2011. The economy continued to be supported by strong client demand, as evidenced by the sharpest rise in new orders in over six-and-a-half years.

Germany
German services PMI rose to 82-month high of 57.3, while composite PMI rose to 59.0, the highest level in 81-months. The survey results highlight the best round of job creation in the private sector economy for nearly seven years, which adds further pressure to an already-squeezed labor market. Panellists reported higher salaries contributing to sharply
rising operating costs, the outcome of which was a pick-up in inflationary pressures. Prices charged for goods and services showed the steepest monthly increase since records began in late-2002.

The Eurozone
The Eurozone economic growth near a 12-year high as the composite PMI rose to 58.8 in January from 58.1 in December. The composite PMI is at the highest level since June 2006.

For that reason, the 0.6% GDP rise signaled by Eurostat’s preliminary flash estimate for the fourth quarter of 2017 is likely to be revised higher to approach the 0.8% indicated by the PMI.