Euro area Watch: PMIs with encouraging start into 2023

With regard to the PMI surveys, the new year is picking up where the old one left off. The preliminary January results for the euro zone published today continued the positive trend that began in November, and the signs of a turnaround are thus becoming stronger. The index for the services sector is now back above the 50-point mark (50.7), while its counterpart for the industrial sector has moved closer to it (48.8 - see the chart below). This puts a further damper on recession fears. However, this should be interpreted carefully, since the interest rate headwind for the economy has not yet had its full effect. In any case, it can be said that the economic risks have recently diminished and that the expected recession is likely to be (even) milder than expected a few months ago.

January PMIs: Further positive trends in manufacturing

With regard to the ECB's monetary policy course, however, a look beneath the surface is at least as relevant. The details show: While corporate input prices continue to decline, the process of passing on the record high purchase prices from 2022 to the downstream production stages and the end consumers has not yet been completed (this development can be seen in the chart below). So there is still quite a bit left in the "inflation pipeline". For euro inflation, this means that the inflation peak was most likely reached during fall. However, the descent from this peak will be a slow and rocky one. This is illustrated not least by a look at the core rate and thus the underlying inflationary pressure. Therefore, it is still too early to sound the all-clear, which is confirmed by today's PMIs. The remarkable resilience of the labor market also speaks for a slow descent from the inflation peak. The employment components of both the industrial and services surveys still do not signal a weak phase on the labor market. While this is encouraging from a business cycle-perspective, it also increases wage pressure. The positive underlying trend on the labor market is unlikely to change much in the coming months either, with the result that in many countries labor shortages could replace supply chain issues, which have already declined significantly, as the No. 1 obstacle to production.

The following environment is therefore emerging for the next few months: a milder phase of economic weakness combined with continued elevated underlying inflationary pressures. An environment that certainly does not argue for a slower pace at the next interest rate meetings of the ECB (which we do not expect either).

PMI industry euro area: Output prices fall less dynamically than input prices