August's flash PMIs were alarming for two reasons. First, the further deteriorating of the manufacturing sector, with businesses reporting that they are now running on the final fumes of the 2022 demand surge. Without a raft of new orders, workers will need to be laid off eventually. Second, the services sector is showing signs of rolling over.
The ECB will consider this from a couple of angles. Long-term inflation is a consequence of a positive output gap, but with new orders slumping and talk of layoffs to come, it is hard to make that case. It will also observe that household spending and business investment is a function of job and order, security - neither of which are apparent anymore. The ECB should skip the September meeting and assess whether recent data is a consequence of the summer lull, or something more untoward. Waiting for layoffs to prove the point would be too late. By the time they are apparent in hard data, the downturn will be entrenched.
As for inflation, with headline Eurozone HICP still at 5.3%, one could easily make the case that it is too early and inflation is too far above target for a pause. But great progress has already been made (inflation was north of 9% at the start of the year), and there are 3.3 percentage points of base effect assistance coming in the next three months.
Rates market pricing made a sharp adjustment after the PMI prints on Wednesday, with September ECB dropping from around 14bp to around 8bp. There's still room to receive here (though the risk/reward dynamics probably switch at sub 4bp). More likely this is a EUR/USD trade — especially if, as expected, Fed Chair Jerome Powell is hawkish at Jackson Hole on Friday. The CB missing September and the Fed guiding that it could still be on for a September hike (which at only 3bp priced has to be a risk/reward pay), should influence FX.
- UBS Strategy
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