Euro zone growth slows as energy costs climb

What happened

Business activity in the euro area grew more slowly in October. The flash composite PMI, a monthly survey of purchasing managers at private companies, fell to 51.9 from 53.1 in September, according to S&P Global on 23 October. Economists polled by Reuters had expected 52.7.

A reading above 50 means activity is still growing, so the economy is expanding, but at the slowest pace in four months. Services activity fell to 51.7 and the manufacturing index to 52.4. New orders barely rose, and hiring stalled.

France’s private sector moved back into contraction amid political turmoil. Germany kept growing, but more slowly.

How an oil shock squeezes firms

The same survey shows costs moving the other way. Factories reported that their input prices rose at the fastest rate since May, driven by higher energy, fuel and transport costs linked to the war in the Middle East.

When costs jump, a firm can either raise its own prices or accept lower profits. Many did a bit of both: selling prices still rose, but more slowly than in September. Households face the same squeeze. Money spent on energy is not spent on other things, so demand elsewhere cools.

This is why an oil shock hits prices first and growth later. Euro area inflation reached 3.8% in September, almost double the European Central Bank’s 2% target, while growth is now losing pace.

Where it sits in the chain

This is step 4 of an oil shock, growth slowing, and it leads straight to step 5: the central bank’s dilemma. The ECB has already raised its deposit rate this year, to 2.50%. Raising it again would lean against inflation but add to the strain on a slowing economy. Holding would ease the strain but risk higher prices spreading into wages.

S&P Global said the survey was consistent with the economy growing about 0.3% a quarter, which is still positive.

What to watch

• The ECB decision on 29 October. Most economists polled by Reuters expect a hold, with a possible rise in December.
• Eurostat’s first estimate of euro area inflation for October.
• Whether France’s contraction deepens or spreads to Germany.