Eurozone economy "stops falling" in June: Composite PMI returns to 50, German data unexpectedly "saves the day"

Eurozone business activity in June outperformed initial expectations. The composite PMI rose to 50.0, returning above the expansion threshold, ending a two-month contraction. Meanwhile, service sector cost pressures cooled at a near-record pace, adding uncertainty to the ECB's future rate path.

According to data released by S&P Global on July 3, the Eurozone's June composite PMI final reading rose from 48.5 in May to 50.0, above the preliminary reading of 49.5, indicating a stabilization and rebound in economic activity after a brief contraction. Among this, the notable upward revision in German data was the main driver of the overall improvement: Germany's June composite PMI final reading rose to 49.5, significantly higher than the preliminary reading and market expectations (originally estimated around 48.5–49.0 range), with the contraction far milder than expected, approaching the expansion threshold.

Chris Williamson, Chief Business Economist at S&P Global, pointed out that easing downward pressure in the services sector, combined with continued expansion in manufacturing, jointly drove the Eurozone economy to stabilize after two consecutive months of output decline.

The data rebound coincides with growing policy divergence within the ECB. Although the ECB implemented its first rate hike since 2023 in June, during this week's annual meeting in Portugal, several officials signaled that last month's action may have approached a sufficiently restrictive level. At the same time, the rapid easing of cost pressures has further weakened market expectations for subsequent rate hikes, making the policy outlook more complex.

Composite PMI returns to expansion zone, Germany sees significant upward revision

The Eurozone's June composite PMI final reading came in at 50.0, an upward revision of 0.5 percentage points from the preliminary 49.5, and also higher than May's 48.5, marking a return to the expansion zone for the first time since March. The rebound in manufacturing output partially offset the impact of the services sector, which remained in contraction but showed marginal improvement.

Germany was the main source of this upward revision. Its June composite PMI final reading rose to 49.5, and the services PMI final reading rose to 48.6, a significant upward revision from the preliminary 46.8, reaching the highest level since the current downward cycle began. Although still in contraction territory, the pace of contraction has narrowed notably.

Phil Smith, Associate Director of Economics at S&P Global, noted that Germany's services sector remains weighed down by geopolitical and external environment uncertainties, with new orders declining continuously and overseas demand continuing to weaken.

Services cost pressures cool significantly, inflation pressures ease

The most notable change in the data came from the cost side. Eurozone services input cost inflation slowed for the first time since October last year in June, dropping to a four-month low, with the decline being the second largest since records began in 1998, second only to the initial pandemic period in 2020.

The price increases passed on by services to end customers also narrowed, indicating an overall retreat in price pressures. The improvement in cost side is related to the pullback in energy prices. The market had previously been concerned about the impact of the Middle East situation on oil prices, but recent consecutive declines in oil prices have alleviated imported inflation pressures.

Nevertheless, the Eurozone's headline inflation rate for June remained at 2.8%, above the ECB's 2% policy target.

Weakness in demand side hard to hide, divergence in policy path intensifies

Despite easing cost pressures, the demand side remains under pressure. New orders in the Eurozone services sector continued to decline in June, overseas demand contracted for several consecutive months, and order backlogs were cleared at an accelerated pace, indicating insufficient demand momentum.

Employment showed divergence. Germany's services employment declined for the sixth consecutive month, but the decline narrowed; the overall Eurozone services employment recorded its fastest growth since the beginning of the year, a slight rebound from May. Meanwhile, business confidence improved to its highest since February, reflecting some recovery in medium-term expectations, but short-term demand remains weak.

Against the backdrop of interwoven inflation and growth signals, the divergence within the ECB over the subsequent policy path has widened. The June rate hike was seen as a forward-looking measure to address inflation risks arising from geopolitical conflicts, but some officials have hinted during recent meetings that a wait-and-see phase may be entered.

The rapid decline in services cost pressures provides more support for those advocating for a rate hike pause. The market generally believes that the ECB will likely shift to a data-dependent model, deciding whether to further tighten policy only after assessing the continued downward trend in price pressures.

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