European economy starts 2018 in good health, upping expectations on ECB

The eurozone has started 2018 strongly, with growth at a near 12-year high and the largest payroll gain since 2000, according to data published on Wednesday.

The early 'flash' reading of the IHS Markit eurozone purchasing managers' indices were led by the service sector's fastest growth since August 2007 but held back by a slight slowdown from manufacturers.

The composite PMI rose to 58.6 in January, up from 58.1 in December and the highest since June 2006.

Manufacturing output growth slowed but the sector continued to perform well overall; according to IHS Markit, the latest three months have seen the strongest factory output increase since 2000.

The flash eurozone services PMI rose to 57.6 in January from 56.6 in December, while the manufacturing PMI dipped to a two-month low at 61.1 against 62.2 in the previous month. A PMI above 50 indicates growth, so remaining in the 60s suggests the industrial sector is still expanding at a good clip.

Companies expanded their workforce numbers at the greatest extent since September 2000. Factory payroll growth remained close to recent highs, while service sector job gains was the highest since October 2007.

Interest rates remain at 0% in the Eurozone, and the European Central Bank continues to follow a policy of monetary easing. The bank will hold its first meeting of 2018 this week, and economists are not expecting any changes to rates or policy.

But with economic growth, prices and wages continuing to strengthen, inflation is expected to move closer towards the ECB’s 2% target, which could signal changes to monetary policy as the year progresses.

Chris Williamson, chief business economist at IHS Markit, said: “The acceleration of growth pushes the survey data into territory consistent with the economy expanding at a super-strong quarterly rate approaching 1%.

“Price pressures are running at their highest for almost seven years, accelerating further at the start of 2018. Higher oil prices have pushed up costs, but pricing power more generally improved as demand outstrips supply for many goods.

“With such a strong start to the year, expect to see forecasters mark up their expectations of Eurozone growth and inflation in 2018, and for policymakers to sound more hawkish.”

Economist Florian Hense at Berenberg said the PMI surveys have two implications for Thursday's ECB meeting.

"First, underlying price pressures are building, gradually and not only in Germany – the PMI input and output price index reached 7-year highs. While the recent uptick is partly due to higher oil prices, producers’ pricing power has also risen. As demand is outpacing supply growth, businesses start to raise prices that go beyond just passing on the higher input costs. This smells like the demand-pull inflation the ECB is looking out for, even if this is early on.

"Second, the surveys do not signal that the stronger euro had an impact on businesses’ activity or outlook. The ECB may, therefore, not need to use its words tomorrow too carefully when being asked on the next steps."

However, after the euro rose to a new three-year high against the dollar as it climbed above 1.23 on Wednesday morning, Hense still expect ECB chief Mario Draghi to use some "verbal intervention" to slow down further gains .