In April, the euro area manufacturing PMI remained below the recession indication level of 50 for the third consecutive month and showed only a small rebound to 47.9, signalling a lacklustre start to Q2 for the economy. However, the service sector still underpins growth, although the services PMI edged down slightly to 52.5 in April. On a positive note, manufacturing new orders showed the first increase since December 2017, driven by a less pessimistic assessment of the export outlook, signalling that we might be past the trough in the manufacturing sector. Overall, sentiment data continued to be mixed in April, with the German Ifo also stalling its upward trend, indicating that the economy is not yet out of the woods. This said, our Danske growth tracker has broken out of its downward trend and the risk of a euro area recession has subsided recently.
The more optimistic picture that hard data has painted for some months was finally confirmed by Q1 GDP growth surprising on the upside at 0.4% q/q . It is likely rising domestic demand drove the increase, while it is likely the industrial sector ceased to be a drag on growth. Notably the Italian economy moved out of recession, with Q1 growth at 0.2% q/q, while it is likely the German growth momentum also gained some speed despite dire PMI readings in Q1. In light of the euro area figure, we revise up our expectation for German Q1 growth to 0.4% q/q (from 0.2% q/q previously), tracking annual growth in 2019 at 1.1%.
In line with our expectations, the April inflation figures increased notably compared with March on the back of seasonal effects from the timing of Easter. Headline inflation rose to 1.7% y/y, driven by higher energy prices and core inflation, which rose to 1.2% y/y. In our view, it is likely the increase in core inflation was due to higher service prices from package tours and transport services due to the Easter effect. The uptick in core inflation in combination with the strong Q1 GDP number weakens the case for further easing measures from the ECB. However, the ECB does not react to single data points and the true state of underlying inflation pressures will be revealed only in coming months.
At the ECB March meeting, the messages were generally on the soft side and particularly noteworthy was a comment from Mario Draghi that the ECB is looking at ways to mitigate the negative side effects of negative interest rates, playing into the recent discussion about a tiered deposit rate system. However, recent headlines from various Governing Council members suggest that a tiering system is far from a done deal and that it looks increasingly likely that the ECB started the discussion to show markets that it is not running out of tools, rather than due to any imminent implementation.
In Spain, the third general election in four years brought another shake-up in Spain's political landscape , for the first time seeing the far-right Vox party joining the ranks of parliament. This said, it underperformed compared with the polls and its impact on policy making is likely to remain limited, with a centre-left government led by PSOE looking like the most likely scenario for now. Although a period of political uncertainty might lie ahead, markets reacted mutedly to the election outcome (see Spanish Election Monitor - Europe's centre-left stages a comeback , 29 April.
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