Eurozone manufacturing PMI hit a 52-month high in September, with recovering demand triggering renewed inflationary pressures.

The recovery momentum in the Eurozone manufacturing sector continues to strengthen, but the ensuing price pressures are complicating market expectations regarding the European Central Bank's monetary policy path.

On Thursday, S&P Global reported that the Eurozone manufacturing Purchasing Managers' Index (PMI) rose to 52.9 in September, the highest level since May 2022, marking the third consecutive month of increase and surpassing the preliminary reading of 52.7.

New orders grew at their fastest pace since March 2022, with export orders expanding for the second consecutive month, marking the first sustained recovery in external demand in over four and a half years. Meanwhile, both input cost and producer price inflation accelerated for the first time since May, with official data expected to show the eurozone inflation rate rising to 3.6% in September, the highest since September 2023.

The renewed price pressures have already left a clear mark on interest rate expectations. The market is currently pricing in three rate hikes by the European Central Bank (ECB) by mid-2027. Chris Williamson, chief global business economist at S&P Global, stated that continued declines in consumer demand and rising living costs are still dragging down household spending. "Against this backdrop, the renewed acceleration of input costs and factory gate prices is worrying and will further fuel market speculation about additional rate hikes by the ECB."

Recovery accelerates across the board, output index hits 55-month high

The output sub-index of the manufacturing PMI rose to 53.6 in September from 53.3, a 55-month high, indicating that the pace of production expansion continued to strengthen.

The geographical reach of this recovery has also expanded significantly. All eight eurozone economies covered in the survey recorded readings above 50, marking the first time in over four years that all economies have achieved expansion. The Netherlands led the way, followed by Ireland and Austria; Germany and Greece also recorded robust expansion; while Spain, France, and Italy saw relatively moderate growth.

Business confidence subsequently strengthened, with the business confidence index rising to a seven-month high. Backlogged orders increased for the first time since April, purchasing activity accelerated, and supplier delivery times extended, but the delays were the least severe since February.

Demand for investment goods is dominant, with AI and defense spending becoming the core drivers.

Chris Williamson points out that the core engine of this round of manufacturing expansion is demand for investment goods, especially machinery and equipment, with related capital goods output growth reaching its highest level since the rebound following the COVID-19 pandemic.

He stated that this trend primarily reflects the rising demand for artificial intelligence and defense-related equipment. In contrast, demand for consumer goods remains weak, with high living costs continuing to suppress consumer spending.

The job market has also seen positive changes. After more than three years of continuous layoffs, manufacturing employment returned to growth in August and expanded slightly further in September, indicating that the recovery has extended from the output level to hiring and capacity expansion.

Inflationary pressures have reignited, and expectations for a European Central Bank rate hike are rising.

Despite a more comprehensive recovery picture, the return of inflation risks is becoming a key variable for the market. Both input cost and producer price inflation accelerated in September for the first time since May, although the rate of increase remained below the peak levels seen earlier this year.

Official inflation data is expected to be released on Friday, with the market anticipating that the eurozone's inflation rate will rise to 3.6% in September from 3.2% in August, which, if true, would be the highest since September 2023.

The market has already priced in the European Central Bank's policy path, and currently expects three rate hikes before mid-2027. The coexistence of manufacturing recovery and inflationary pressures presents the ECB with a more delicate balance in its policy orientation.

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