Continued resilience in the services sector likely to unnerve the ECB
April PMIs for the euro area showed the economy, and notably the services sector, was far more resilient than many had expected (European PMIs: No recession to see here , 21 April 2023). The increase in aggregate output and new orders/business was drivenentirely by the services sector, with the manufacturing sector instead seeing marked declines in both.
Moreover, price balances showed a similar disparity between the manufacturing and services sectors (see Figures 1 and 2 for a comparison). While price balances did fall on the month for both the manufacturing and services sectors, manufacturing price balances are now printing around pre-pandemic levels, and falls in services price balances were far more muted, resulting in them remaining materially elevated versus their pre-pandemic levels.
In our view, this resilience in the services sector, and in particular the services price balances, will be of concern to the ECB. Indeed, elevated price balances within the services sector support our view that core inflation in the euro area will remain elevated for the near-term. We forecast core HICP inflation for the euro area to print at 5.4% y-o-y in April, after 5.7% y-o-y in March (Euro area: April HICP preview , 21 April 2023). While this does mean a slowing in the seasonally-adjusted monthly growth rate, to 0.3% m-o-m SA from 0.4% m-o-m SA in March, this is nonetheless inconsistent with core inflation descending to the ECB’s 2% target anytime soon.
It is important to caveat that this would correspond to a 0.8% m-o-m NSA growth rate for April 2023, and this would be the third strongest monthly NSA growth rate for April coreinflation since 1997, with only April 2019 and April 2022 having stronger monthly growthrates. That said, as illustrated already, survey measures remain elevated in the euro area, with both input and output price balances at levels inconsistent with a material near-term fall in monthly inflation rates.
An additional likely concern for the ECB, as a result of its current focus on core inflation, is that we expect headline inflation to fall quite sharply during this year owing to energy price deflation, versus our expectation that core inflation will prove more persistent, so much so that we in fact forecast headline inflation to print below core inflation from July onwards.
Ultimately, continued resilience in the euro area economy, with today’s PMIs supporting our view that the euro area will escape a recession, coupled with too high price balances and expectations of sticky core inflation, all support our view that the ECB will hike by 50bp at its May meeting. At the time of writing, market pricing for May’s meeting is 33bp, and markets are currently pricing 80bp of rate hikes by year-end. In some recent ECBspeak, Klaas Knot (source: interview with Irish Times) suggested the ECB would likely raise rates by more than markets are pricing (as a reminder, Nomura expects a further 125bp of hikes).