Euro Area Growth Expands as ECB Hikes Rates Amid Inflation Concerns

The Euro area economy showed stronger growth in September, as the composite Purchasing Managers' Index (PMI) climbed to 53.1, up from 52.0 in August and surpassing expectations. This marked the highest level in over three years, driven primarily by a robust services sector, where the PMI rose to 53.0 from 51.6. Manufacturing remained steady at 52.7, indicating a broadening of economic momentum into the services sector, supported by consumer spending.

Second-quarter GDP growth was initially fueled by manufacturing, but the September PMIs suggest a shift towards more balanced growth. Private consumption unexpectedly increased by 0.3% quarter-over-quarter despite higher energy costs and falling confidence. However, prolonged energy costs pose a risk to consumer spending in the near term, though overall growth appears increasingly broad-based heading into the fourth quarter.

Headline inflation rose to 3.8% year-over-year in September, the highest in three years, up from 3.2% in August and slightly above expectations of 3.7%. The increase was mainly due to energy and food inflation, while underlying inflation pressures remained subdued. Core inflation aligned with expectations, rising to 2.5% year-over-year from 2.4%. The European Central Bank (ECB) raised policy rates by 25 basis points at its September meeting, bringing the deposit rate to 2.50%. The ECB's communication took a hawkish turn, stating that "inflation is set to remain well above target for an extended period," and revised its staff projections upward, signaling potential further tightening.

France's fiscal situation has worsened, with public debt reaching an all-time high of 119% of GDP in the second quarter and this year's deficit expected at 5.4% of GDP, exceeding the initial 5.0% target. The 10-year France-Germany government bond yield spread widened to around 140 basis points, reflecting growing market concerns. Next year's budget is unlikely to improve significantly, as the minority government faces challenges in implementing strong fiscal tightening ahead of the presidential election.