• The flash PMIs for August did little to ease concerns about a slowing euro area economy. A temporary boost to French services from the Olympics helped to bolster the headline number but gloomy news continues to emerge out of Germany. The euro area’s largest economy is clearly struggling and there are few signs of any imminent turnaround in fortunes. Risks around our growth outlook for the euro area as a whole (0.7% in 2024) are tilted to the downside.
• In contrast, the news around the UK economy remains positive. A slowdown from the relatively high growth rates in H1 was always likely but the latest PMI numbers indicate that the expansion will continue in the second half of the year, at around potential. It was a ‘Goldilocks’ PMI release with moderating service sector price pressures helping allay any fears that the economy is overheating. While things are ticking along quite nicely, energy price dynamics mean that headline inflation is likely to increase over coming months and the UK services sector would be exposed to any meaningful US-led downturn. But overall we remain upbeat about the UK outlook.

No recovery in sight yet for the ailing German economy

The flash PMIs for August painted a mixed picture with continued fragmentation across Europe. The euro area composite figure came in at 51.2, a 3-month high and consistent with another quarter of steady growth in Q3. However, the details are less encouraging and the narrative of a ‘two speed’ euro area with the periphery outperforming the core (Germany especially) remains. 

Firstly, the headline euro area composite PMI was flattered by the Olympic boost for the services sector in France. This looks a one-off distortion with various forward-looking components suggesting that French services activity will return back to the pre-games level, or weaker, over coming months. Expect some volatility in the GDP numbers with a strong Q3 followed by contraction in Q4.

At the same time there is no sign of any relief for the struggling German economy. The composite output PMI fell to a 5-month low (48.5) and is consistent with another mild contraction in Q3. German GDP is just 0.35% above the Q4 2019 level and, given the challenging outlook, it seems increasingly fair to use the ‘sick man of Europe’ tag.

At the start of the year we said it was hard to make the case for a meaningful turnaround in the export-focused German manufacturing sector in the absence of a global upswing (see here). Since then external conditions have shifted in the wrong direction – the world manufacturing PMI (ex. euro area) has weakened sharply in recent months and is now close to the breakeven mark. With heightened concerns of a US-led slowdown, there is now the threat of extra cyclical pressures being added to the long-term structural headwinds facing the German economy. We look for another year of stagnation with flat annual average GDP growth this year.

Chart 1: The German economy continues to weigh on overall euro area activity

Chart 2: A K-shaped euro area recovery? Clear divergence between manufacturing and services output

The contrast with the rest of the euro area remains clear. The PMI for the euro area ex. Germany and France continues to hum along fairly nicely, still in expansion territory (Chart 1). But with the largest economy continuing to act as a brake on overall activity rather than returning to modest growth it’s clear that there are risks to the euro area outlook. Our current forecast is for GDP growth of 1.4% in 2025, around potential, but that assumes steady growth in H2 with the start of a mild recovery in Germany. A meaningful slowdown around the turn of the year could see that annual average forecast become increasingly optimistic. Aside from the PMIs, euro area consumer confidence fell slightly in August after six months of steady gains which only adds to the sense that risks to the growth outlook are tilted to the downside. That said, it’s worth highlighting that there is also some upside potential stemming from the other side of the Atlantic. Should the US election not lead to tariffs on European goods and/or there is a soft landing for the US economy then we’d expect a boost to confidence numbers in Europe.

On the effect of monetary policy, sentiment doesn’t seem to have been bolstered much by the ECB’s rate cut in June (perhaps because it was long-trailed in advance) but a more established easing cycle would likely lift spirits, for both households and industry. The latest PMIs showed a mixed picture on price pressures but the ECB will be glad to see services input costs fall to the lowest since April 2021. There was more significant information this week in the form of negotiated pay data for Q2 which showed a big slowdown to 3.6% Y/Y (from 4.7% in Q1). There are still reasons for caution ­– headline inflation was up slightly in July, to 2.7%, and there was bad news on productivity with another drop in Q2 – but overall our sense from the PMIs and more broadly is that the disinflation process remains on track. Market participants have more or less fully priced in another cut at the next ECB meeting (12 September), in line with our expectations.

The UK economy continues to tick along nicely

It was a good set of PMI numbers for the UK. The composite output figure increased to 53.4, a four-month high, suggesting that the economy will continue to expand in H2 after a strong start to the year. Unlike in many other advanced economies the UK manufacturing sector remains in reasonable health, although that seems to be supported mostly by domestic demand with export orders still weak.

In other survey news, UK consumer confidence remained at its July level, almost a three-year high, with encouraging signs that households’ appetite for major purchases has increased. All told, the period of stagnation in 2023 now seems to be firmly in the rear-view mirror and our base case remains that the UK economy will tick along fairly nicely both this year and next, with growth rates hovering around potential. A US-led slowdown, which would weigh on UK services exports, is the most obvious downside risk.

In good news for the BoE, the PMI also showed signs of moderating service sector price pressures which would help allay any fears that the economy is overheating. This leaves the path clear for further monetary easing after officials started the ball rolling on rate cuts in August. That said, headline inflation is set to rise further over coming months on the back of energy base effects. It was also announced today that household energy prices will rise by 10% from October, slightly more than we had expected. The underlying disinflation trend is set to continue but rising headline rates might pose some communication challenges ahead for policymakers.