Euro area: Services PMI and inflation risks – BNY

Geoff Yu at BNY argues that the lack of further Fed tightening has eased global financial conditions and partially offset European Central Bank (ECB) tightening, but European inflation dynamics remain distinct from the U.S. The report favors received positions in European rates, while warning that rising services PMIs, elevated input costs and margin pressure could undermine a sustainable demand recovery and pose stagflation risks for the Euro area.

European PMIs and rate positioning

"The lack of additional tightening by the Fed has led to hopes of easier financial conditions globally and helped offset some ECB tightening through the external channel. Falling prices for dollar-priced commodities will generate some negative pass-through on the margins, but until there is clear visibility over the conflict, rates markets are unlikely to remove the near 45bp currently priced in additional tightening by year end."

"As long as this balance holds, we favor adding to received positions in European rates, which will also help alleviate financial conditions on the margins. We stress that the European inflation situation remains fundamentally different from that of the U.S., where there is a stronger demand case, led by investment growth."

"Based on the Eurozone PMI details, the fundamentals behind services recovery don’t bode well for a sustainable demand lift. Softer headline prices have helped with the recovery, but the effect of price changes is overstated."

"Even as the ceasefire was implemented, Services PMI input prices remained at their highest levels since early 2024. The spread between input and charged prices is now at its widest in nearly three years, pointing to significant margin pressure across the sector."

"For a country with the worst real rates in emerging markets, by some distance, the outlook for the currency will deteriorate further."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)