Euro zone growth surges despite higher energy prices

Despite soaring energy costs due to conflicts in the Middle East and Ukraine, the European Union's economy has demonstrated strong growth, according to recent business surveys. The S&P Global Flash Euro Zone Composite PMI Output Index surged to 53.1 in September from August's 52.0, indicating robust expansion in activity. This marked the fastest growth in the region in over three years, defying expectations of a decline in the Reuters poll.

The index, which signals growth above 50.0, was driven by solid performance in both manufacturing and services sectors.

Key contributors to this growth included Germany and France, both of which experienced solid increases in business activity despite facing pressure from rising inflation. In Germany, the largest economy in Europe, business activity expanded strongly in September, while France saw its fastest pace of growth in over two years, fueled by a resurgence in demand for services.

Meanwhile, the United Kingdom, outside the EU, saw a slowdown in growth due to mounting inflation pressures, according to its PMI data, which presents a challenging scenario for Finance Minister John Healey before his upcoming budget.

Overall new orders in the currency union surged to their highest level in over four years, driven by a further rise in exports. This included intra-euro zone trade, indicating a robust economy. The services PMI in the bloc reached its highest level in nearly a year and significantly surpassed expectations, while the manufacturing index remained steady. Additionally, the output gauge, which feeds into the composite PMI, showed a modest uptick.

While firms have capitalized on the increase in demand by hiring more staff, they have also faced higher input costs due to heightened energy prices stemming from the U.S. conflict with Iran. These firms managed to pass some of these costs onto consumers. According to Jack Allen-Reynolds at Capital Economics, "September's big improvement in the euro zone's composite PMI supports our view that despite the weakness in the official activity data in July, GDP will increase in Q3."

The composite PMI's rise also suggests that there are no immediate signs of "second-round" effects on wages.

Prior to these findings, the European Central Bank had raised interest rates for the second time in 2023 to curb inflation driven by energy costs and issued warnings about the potential for lasting price pressures. Markets are pricing in three more ECB rate hikes by the end of June 2027. ING's Carsten Brzeski noted that the latest PMI readings are so positive that they seem "almost too good to be true."

He added that "a euro zone economy that remains completely unharmed by an energy price shock and supply chain disruptions is a welcome surprise. Let's hope it doesn't turn out to be a mirage."