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Eurozone appears to be on the mend, but ECB remains on track to cut interest rates in June
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For the euro, the interest rate outlook from June onwards is becoming increasingly important.
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PMI preliminary figures for April are scheduled to be released on Tuesday at 08:00 GMT
Will PMI confirm signs of lukewarm recovery?
The euro zone economy stagnated in mid-2023, but narrowly avoided a technical recession, defined as two consecutive quarters of negative growth. The latest data is somewhat optimistic, and the eurozone may be turning a corner.
S&P Global research shows that service sector activity has expanded in the past two months, pushing the overall composite PMI above 50.0 for the first time since May 2023, although the manufacturing sector remains in a dire situation. It was enough.
With China's economic recovery gaining some momentum and the energy crisis waning, the pain for European manufacturing is expected to ease further significantly in the coming months.
Forecasts call for the services PMI to rise further to 51.9 and the manufacturing PMI to improve to 46.5 in April.
waiting for the last piece of the jigsaw
For policymakers at the European Central Bank, the biggest concern is of course inflation, and things are looking up on that front as well. Headline inflation fell to 2.4% in March, and unlike the United States, where progress has been mixed, fundamental indicators have been on a downward trend throughout the year.
Some ECB officials were prepared to cut interest rates in April, but most Governing Council members, including Lagarde, are still not fully convinced. Services inflation in particular remains problematic, and policymakers will need to see wage pressures subside before they can be confident that services CPI, currently at 4.0%, will not remain high.
As service prices tend to correlate more strongly with wage growth than manufacturing prices, the ECB will make the June cuts fully clear by pre-empting first-quarter statistics on negotiated wages, which will be published at the end of May. waiting.
Hopes for interest rate cuts are set back
In this regard, the PMI numbers will not be a hindrance to the prospects for a rate cut in June. But they could shape expectations for the path of interest rates beyond June. Bets by global central banks to cut interest rates have been sharply reduced over the past month following a series of strong U.S. indicators that dampened hopes for aggressive Fed easing.
Expectations for the ECB to cut interest rates have also receded, with investors pricing in a rate cut of just under 75 basis points. If the PMI data is better than expected, the June rate cut will likely remain steady, but doubts about further easing in the second half of the year may be further heightened.
Will the euro be able to recover its recent losses?
The euro has been under pressure lately as the ECB looks set to take its hands off the brakes before the Fed. The currency hit a five-month low of $1.0599 earlier this week, before rebounding to around $1.6050. If the PMI survey is positive, the euro could recover further towards its April high of $1.0885.
On the other hand, an unexpected deterioration in PMIs would put new pressure on the euro as investors seek to ratchet up bets on interest rate cuts in June and the rest of the period, which are not fully priced in. Probability is high. Year. In such a scenario, the euro could break through the 78.6% Fibonacci retracement of the October-December bull market at $1.0595 before heading towards the October 2023 low of $1.0447.
Hawkish Fed could frustrate ECB doves
If growth does not recover, the Fed and ECB's divergent monetary policy directions could weigh on the euro even more in the coming months. However, this may also pose upside risks. If the Fed does not cut interest rates this year due to persistent inflation, the euro could fall sharply, making it difficult for the ECB to diverge significantly from the US response.
Meanwhile, markets may also be overlooking the possibility that the economic recovery could jeopardize the ECB's interest rate cut target. Moreover, the continuing threat of further escalation of tensions in the Middle East is something ECB policymakers are watching closely due to the risk of rising oil prices.
