(Bloomberg) -- A shock decline in the euro zone’s main survey of the private sector economy just gave the European Central Bank a reason to speed up interest-rate cuts — at least in the eyes of investors.
Whether that means another reduction next month is unclear — markets assign a 40% chance to such a move. But Monday’s unexpectedly large decline in the region’s composite Purchasing Managers’ Index has them pricing 43 basis points of monetary easing by year-end — up from 38 earlier — suggesting a bigger step at December’s meeting is also possible.
Similar sentiments rippled through bond and currency markets: A key segment of the German yield curve normalized and the euro slipped after Mondays’ data from S&P Global.
“Today’s PMI data surely adds to growth worries and increases the likelihood of another cut in October,” said Jussi Hiljanen, a strategist at SEB. “But it’s not decisive — they will make a comprehensive analysis where PMIs are just one piece of the puzzle.”
Fears are growing that Europe’s early-year recovery has run out of steam. Output in the bloc’s 20 nations already began to fade in the second quarter, with consumers still hesitant to open their wallets even as they benefit from cooling inflation and rising wages. Weak foreign demand — especially in China — is also weighing on factories. Troubles at German carmakers like Volkswagen AG underscore the issue.
S&P Global’s release showed that much of September’s economic weakness was down to an unwinding of the boost France got from hosting the Summer Olympics. As a result, its index of services activity fell well below the 50 mark separating growth from contraction. Germany’s manufacturing malaise worsened, meanwhile, contributing to a fall in the overall gauge for the euro area to 48.9. Economists had predicted 50.5.
While ECB staff have already trimmed this year’s economic-growth forecasts, they still see expansion of 0.8% — driven to a large extent by a pickup in consumer spending. Households have remained cautious so far, with conflicts in Ukraine and the Middle East — as well as volatile politics — all casting a shadow over their situations.
Some of the ECB’s more dovish policymakers warn that if rates stay too high for too long, the economy could suffer unnecessary damage. Executive Board member Piero Cipollone said recently that “there’s a real risk that our stance could become too restrictive.”
What Bloomberg Economics Says...
“The composite PMI has flagged a deterioration in the economic outlook. In part, that reflects a back-to-reality drop in France after the completion of the Paris Olympic Games. We expect the euro area to grow 0.2% in the third quarter, unchanged from 2Q. For the ECB, a pronounced growth slowdown would be unwelcome. If further evidence of a slowdown builds, that could make the October gathering a live meeting.”
—Jamie Rush, chief European economist. Click here for full REACT
Hawks, though, are in no rush to deliver more easing, citing stubbornly high services-sector inflation that could delay a return to the 2% target. Latvia’s Martins Kazaks said Monday, before the PMI data, that the price threats still trump growth concerns.
“The risk of service-price inflation is still more significant at the moment, but as we move forward step by step, we’ll see how the situation develops,” he told the Leta newspaper.
Slovak central-bank chief Peter Kazimir said last week he’d need a “powerful signal” about the economic outlook to support an October cut.
The question is whether the PMI release amounts to that. Other data due before the next ECB meeting include the monthly Ifo survey on Germany’s economy and September’s euro-zone inflation reading.
Speculation on quicker loosening has also been fueled by the Federal Reserve’s forceful start to its rate-cutting campaign, even as the US economy keeps growing. PMI data later Monday are expected to show a broadly unchanged reading of 54.3.
“The market is almost demanding more aggressive rate cuts, especially after what we have seen the Fed has done,” Marija Veitmane, a strategist at State Street, told Bloomberg TV. “The ECB is definitely behind the curve and needs to do more.”
Lauren van Biljon, head of rates & FX for the global fixed-income team at Allspring Global Investments, agreed that the ECB’s focus on services inflation is “misplaced.”
“Right now, we’re pricing in the most policy movement in the US — which is fascinating given growth is still well above all other developed market peers,” she said.
But it may yet take more evidence to persuade the ECB’s 26-member Governing Council of the need for another cut in October.
“The risk of a recession has increased and the ECB needs to think hard about whether the base case of a moderate acceleration of growth in the coming months still holds,” said Dirk Schumacher, an economist at Natixis. “But for such a re-assessment to take place, these weaker PMIs need to be ‘backed up’ by hard data.”
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