Euro zone business activity expanded in August at the fastest pace since November, according to S&P Global's flash purchasing managers' index data released on Friday, with new orders, exports and hiring all moving into firmer territory during a quarter already disrupted by the U.S.-Israeli military campaign against Iran.

The composite PMI, which combines manufacturing and services, pointed to the strongest expansion in nine months. New orders grew at their quickest rate in 40 months. Exports expanded for the first time since February 2022. Employment, which had contracted through the first half of the year, returned to growth. And price pressures continued to ease.

Taken together, the figures suggest the 21-country currency bloc has carried its second-quarter momentum into the third quarter. Eurostat's preliminary GDP estimate showed the euro zone grew by 0.4 per cent in Q2, a pace that exceeded most forecasts. If August's PMI readings are a reliable guide, the current quarter could deliver something comparable.

How the PMI surveys work

S&P Global's purchasing managers' indices are compiled from survey responses submitted by executives at thousands of companies across the euro area. A reading above 50 signals expansion in activity compared with the previous month; below 50 signals contraction. The flash estimates published on Friday are based on roughly 85 per cent of the usual monthly responses, giving an early read before the final data are released in early September.

PMIs do not measure output in absolute terms. They measure the direction and speed of change. A composite reading of 53 means activity is growing faster than the previous month, but it does not tell you the size of the economy. Because the surveys are published quickly, often within days of the reference period ending, they are watched closely by the European Central Bank and by investors as a leading indicator of gross domestic product.

Manufacturing leads the improvement

The most striking element of the August data is the contribution from manufacturing. New orders in the factory sector grew at their fastest rate in over three years, reversing a prolonged stretch in which industrial firms reported shrinking backlogs and cautious purchasing.

This matters because euro zone manufacturing has been the weak link in the bloc's economy for much of the period since the pandemic recovery peaked in 2021. Germany, the largest economy in the currency union, has been in or near recession for several quarters, dragged down by its export-oriented industrial base. If factories are now seeing stronger demand, that points to a broadening of the recovery beyond the services sector, which had been carrying growth almost single-handedly.

The return of export growth reinforces that picture. Exports have not expanded since February 2022, a stretch of more than four years that encompasses the energy crisis triggered by Russia's invasion of Ukraine, the subsequent collapse in German industrial orders, and the more recent disruption from the conflict involving Iran. The fact that foreign demand is now rising suggests that the worst of those external shocks may be receding, or at least that euro zone exporters are finding alternative markets.

Employment turns positive

Employment moved back into expansionary territory in August for the first time since December. Hiring had been weak through the spring, with companies reluctant to add staff while demand remained uncertain. The shift in August implies that firms are seeing enough improvement in their order books to justify taking on workers, a signal of confidence in the durability of the upturn.

Labour market data from Eurostat has shown the euro zone unemployment rate hovering near historic lows for months, but that has partly reflected workers leaving the labour force rather than strong hiring. A PMI employment reading above 50 suggests actual job creation is picking up, not just that the pool of jobseekers is shrinking.

Price pressures continue to ease

The August surveys also showed easing price pressures. Input costs and output charges rose more slowly than in July, continuing a disinflationary trend that has been in place since the peaks of 2022 and 2023.

For the European Central Bank, which has been cutting interest rates in response to falling inflation, the PMI price data will provide reassurance that the disinflation process remains on track even as growth accelerates. The central bank's governing council has repeatedly stated that it does not need to see inflation at its 2 per cent target to continue easing policy, but it does need to be confident that price growth is moving in the right direction. The August data support that view.

The distinction between goods and services inflation matters here. Goods inflation has fallen sharply, but services inflation, which is closely linked to wage growth, has been stickier. The PMI data suggest that input cost pressures are moderating across both sectors, which, if sustained, would give the ECB room to cut rates further at its September meeting. The ECB's press section will publish the account of the governing council's discussion in due course.

Resilience under geopolitical strain

The August PMI readings carry additional weight because they come during a period of significant geopolitical disruption. The U.S.-Israeli military action against Iran has unsettled energy markets and raised concerns about supply routes through the Middle East. Earlier in the summer, oil prices spiked on fears that the conflict could disrupt shipments through the Strait of Hormuz, through which roughly a fifth of global oil supply passes.

Those fears have not fully materialised, and oil prices have retreated from their mid-summer highs. But the conflict has added a layer of uncertainty to business planning, particularly for energy-intensive manufacturers in Germany and central Europe. The fact that euro zone companies continued to expand activity and hire workers in August suggests that the economic impact of the conflict, at least so far, has been contained.

That resilience is not guaranteed to last. A widening of the conflict, a sustained disruption to shipping lanes, or a fresh spike in energy prices could quickly reverse the gains visible in the PMI data. For now, though, the surveys paint a picture of an economy that is coping with external shocks better than many expected.

What the data do not reveal

Several questions remain. The flash PMIs do not provide country-level breakdowns; those will come with the final data in early September. It is unclear whether the improvement is concentrated in the larger economies, such as Germany, France and Italy, or whether it is more broadly based across the smaller member states. A recovery led by Germany would carry different implications for ECB policy than one driven by the periphery.

The durability of the export recovery also depends on factors outside the euro zone's control. If the conflict involving Iran escalates, or if the United States economy slows more sharply than expected, demand for European goods could weaken again. China's appetite for euro zone exports, which has been soft for much of the past two years, remains another variable.

And while easing price pressures are welcome, the ECB will want to see confirmation in the official inflation figures before deciding how far to cut rates. PMI price indices are directional indicators, not substitutes for the harmonised index of consumer prices that the ECB targets.

Organisations

S&P Global · European Central Bank