Stagflation alarm sounded! Eurozone's composite PMI in March fell to a 10-month low, France's PMI declined for three consecutive months and entered contraction.

The Middle East war has pushed up energy costs and suppressed the service sector, placing the European Central Bank in a dilemma between growth and inflation.

Private sector activity in the Eurozone hit the brakes sharply in March, with the composite PMI falling to a ten-month low and stagflation risks sounding the alarm. The unexpected rebound in manufacturing failed to offset the broad weakness across the service sector, while surging energy prices and supply chain pressures caused by the Middle East conflict are fundamentally reshaping the European economic outlook.

According to preliminary data released by S&P Global on Tuesday, the Eurozone’s composite PMI in March fell from February’s 51.9 to 50.5, below analysts’ expectation of 51 and marking the lowest since last May, though it just managed to hold above the critical 50 threshold. The service PMI’s preliminary reading dropped to 50.1, far below the expected 51.1; manufacturing PMI, on the other hand, unexpectedly climbed to 51.4, a 45-month high and above the forecast of 49.6.

Germany and France cool down together. Germany’s composite PMI fell to 51.9, exceeding expectations. Manufacturing unexpectedly strengthened, partly due to clients stockpiling goods ahead of time to mitigate supply chain risks from the conflict. France’s composite PMI dropped to 48.3, a five-month low and below the expansion threshold for three consecutive months.

After the data release, financial markets reacted relatively calmly. The yield on Germany’s 10-year government bonds remained steady at around 3%; the euro fell slightly by 0.2% to $1.1593. Money markets continued to price in tightening, with about 70 basis points of rate hikes expected by year-end.

Stagflation Warning: Surging Costs and Slowing Growth in Parallel

S&P Global’s Chief Business Economist Chris Williamson stated, "The flash PMI for the Eurozone in March is sounding the stagflation alarm—the Middle East conflict is sharply pushing up prices while curbing growth." He pointed out that with energy prices surging and supply chain disruptions due to the conflict, business costs are rising at the fastest pace in over three years.

According to S&P Global, the pace of input price increases in March was the fastest since February 2023, with surveyed companies pointing to broad rises in energy, fuel, transportation, wages, and various raw material costs. Supply chain pressure is also beginning to accumulate, with disruptions to sea freight and delays in deliveries from Asia becoming apparent.

Corporate future output expectations saw the biggest drop since the outbreak of the Russia-Ukraine conflict, reflecting deep pessimism about the outlook.

Williamson stated that the current situation, "will force the European Central Bank to proceed cautiously at the policy level in the face of increasingly clear and rising stagflation risks over the next few months."

Germany and France Cool Down Together; Services as Main Drag

Subcomponent data for the Eurozone’s two largest economies further reveals internal divergence.

Germany’s composite PMI fell from 53.2 to 51.9, a decline larger than expected (forecast was 52.2), but still remained in expansion territory. Manufacturing unexpectedly strengthened, partly due to clients stockpiling goods to avoid supply chain risks from the conflict; but services PMI recorded only 51.2, significantly below market expectations.

S&P Global economist Phil Smith warned, "Manufacturing output expectations have been revised down, which means the surge in factory activity is likely to be short-lived." Germany, previously at a turning point due to fiscal spending, has seen recovery momentum again hampered by external shocks.

France’s situation is more severe. The composite PMI fell further from 49.3 to 48.3 in March, a five-month low and below the expansion threshold for the third consecutive month, also worse than Bloomberg’s survey expectation of 49.3. The services PMI fell to 48.3, while manufacturing remains in expansion but provides limited support to the overall outlook.

S&P Global Chief Economist Joe Hayes noted, "For now, France’s budding recovery appears to have been put on hold." He stated that rising inflation risks, long-term supply-side disruptions, and increased recent uncertainties are prompting companies to reassess their outlook, and business confidence has declined sharply.

ECB’s Dilemma: Policy Space Narrows Sharply

The European Central Bank is currently in a wait-and-see mode, needing to deal both with inflationary pressures brought by the Middle East situation and weigh uncertainties posed by Trump possibly shifting policy stance at any time. According to Bloomberg citing insiders, officials do not rule out raising rates at the April policy meeting.

Chris Williamson believes that faced with an “explicit and rising stagflation risk in the coming months,” the ECB “will have to proceed cautiously on policy.”

He points out that PMI data shows “The ECB is no longer in a favorable position regarding growth and inflation”—slowing growth and accelerating cost rises are coexisting, sharply reducing the policy space for monetary adjustment. The duration of the Middle East conflict and its potential long-term impact on energy and supply chains will be key variables determining the eurozone economic outlook.

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