Euro Area’s Worsening Downturn Fuels Bets on ECB September Pause

The contraction of private-sector activity in the euro area intensified, leading investors to bet that the European Central Bank will pause its campaign of interest-rate hikes next month.

(Bloomberg) — The contraction of private-sector activity in the euro area intensified, leading investors to bet that the European Central Bank will pause its campaign of interest-rate hikes next month.

Services in August ceased being a bright spot and followed the industrial sector into a downturn in the region’s top two economies, prompting the shift in market wagers and sending bond yields and the euro tumbling.

The figures also brought warnings that output in the 20-nation bloc will shrink this quarter.

The flash Purchasing Managers’ Index for the region fell to 47, further below the 50 threshold indicating growth. Services activity shrank for the first time since end-2022, while the expectation was for continued expansion in a sector that had until recently seen robust demand.

Separate data for the UK showed private-sector firms suffered their first contraction in seven months.

“The PMIs were very weak and highlight the dire outlook for Europe’s largest economy and the risks ahead of the September ECB policy meeting,” said Valentin Marinov, head of G10 FX strategy at Credit Agricole.

The figures were particularly dire in Germany, where overall activity declined at the fastest pace since the first wave of the pandemic brought the economy to a screeching halt in May 2020. France reported a third monthly drop in output, while the rest of the region contracted more moderately. 

The data indicate that the euro area will shrink by 0.2% in the third quarter, compared with 0.3% growth in the three months through June, according to Cyrus de la Rubia, chief economist at Hamburg Commercial Bank.

“It strengthens the hands of those arguing for a ‘pause’ in September,” said Dirk Schumacher, an economist at Natixis SA. “The economy is clearly not doing well given these figures.”

European bonds rallied, with the 10-year German yield falling as much as 12 basis points to 2.53%, its lowest in nearly two weeks. Traders now price a 40% chance of a quarter-point ECB hike next month, compared to 55% before the release.

What Bloomberg Economics Says…

“The Governing Council remains worried about upside risks to the inflation outlook and our current view is that this will prompt them to deliver a last rate hike in September. But signs of a slowdown in the economy may well dominate and force the Governing Council to pause”

—Maeva Cousin, economist. Click here for full REACT

The euro fell against most of its Group-of-10 peers and reached a one-year low against the pound before the move was pared as weak UK PMI figures dragged sterling down. The common currency weakened as much as 0.3% against the dollar to a two-month low at $1.0810, while the pound dropped 0.6% to $1.2650.

“The service sector of the euro zone is unfortunately showing signs of turning down to match the poor performance of manufacturing,” de la Rubia said in a statement. “Service companies reported shrinking activity for the first time since the end of last year, while output in manufacturing dropped again.”

Earlier numbers from Australia pointed to a deepening slump, while a measure for Japan showed solid growth. Figures from the US are predicted to show stable growth.

While slowing activity should support an ECB pause, Wednesday’s PMI report also came with a warning over stubborn price pressures.

Headline rates of input cost and selling price inflation moved higher in August, partly due to wages, S&P Global said. The measures still signaled far lower pressures than seen over much of the past 2 1/2 years.

“If core inflation surprises on the upside while the economic outlook is deteriorating, the ECB may be tempted to rush into one last hike in September, which may be effectively their last opportunity to hike,” said Francesco Pesole, FX strategist at ING.

There were also signs that the labor market, which has so far remained resilient against worsening economic prospects, is starting to feel the pinch. Hiring nearly stalled as companies confronted a gloomier outlook for the year ahead, S&P Global said.

Business confidence fell, largely driven by lower backlogs of work. Companies also cited concerns “over broader economic slowdowns at home and in export markets,” the report said.

–With assistance from Mark Evans, Joel Rinneby, James Hirai, Greg Ritchie and Dayana Mustak.

(Updates with market moves, comments and context throughout.)

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