December ECB rate hike hinges on oil prices and France’s budget

The eurozone economy is still growing, but the momentum is fading. The October flash composite PMI fell to 51.9 from 53.1.

That is a four-month low, and below every forecast in a Reuters poll, which expected 52.7. Any reading above 50 means expansion.

S&P Global says this pace is consistent with quarterly GDP growth of about 0.3%.

The slowdown is broad. Services slipped to 51.7 from 53.0, while manufacturing fell to 52.4. But the damage is uneven.

Germany’s composite PMI held up at 52.8.

France is the problem. Its composite PMI plunged from 51.1 to 48.4, with both manufacturing and services back in contraction.

The survey reading should be treated with caution, but the direction is clearly negative for the eurozone’s second-largest economy.

French budget vote on Nov 17 is the trigger

The reason is political as much as economic.

France’s minority government must pass a 2027 budget, with a vote scheduled for November 17, and a presidential election follows in 2027.

The deficit is estimated at about 5.4% of GDP this year, and the draft budget aims to cut it to 5%.

Investors are not convinced.

French yields touch 5%, spread near 150bps

The 10-year French yield briefly topped 5% on October 21, its highest since 2002, and the spread over German bunds widened to around 157 basis points.

That is close to the levels of the 2011 sovereign debt crisis.

Firms pass on costs, demand starts to bend

The second pressure is energy.

The Iran war is keeping energy prices above $100, and oil is up almost 80% this year.

Input costs accelerated for a second month, driven by higher energy, fuel and transport costs.

Manufacturing is taking the hit.

Selling prices are rising more slowly, which means companies are absorbing part of the shock and margins are thinning.

Williamson of S&P Global also flagged a quieter risk. Higher interest rates are starting to dampen demand.

Bond markets tighten before ECB does

This is the dilemma for the European Central Bank.

It raised rates in June and September, taking the key rate to 2.5%.

Growth is resilient and inflation is above target, which argues for more tightening.

But French bond yields are already tightening financial conditions on their own.

Christine Lagarde has noted that long-term rates have climbed markedly since the last meeting.

So expect a pause.

The ECB meets on October 29 and is widely expected to hold at 2.5%.

The signal is not a pivot. It is a delay.

Analysts say any further hike will probably wait until December, when new staff projections arrive.

Core inflation rose only slightly to 2.5% from 2.4%, so there is no sign yet of a wage-price spiral.

Three variables will decide what comes next:

• Oil: the longer it stays above $100, the stronger the case for hikes.
• Paris: a credible French budget would calm bonds and free the ECB to keep tightening. A deadlock leaves the bond market doing the tightening for it.
• Pass-through: if energy costs spread into services and wages, the ECB will move.

For now the eurozone is resilient but fragile.

Germany is carrying the growth, France is carrying the risk, and the ECB is caught between them.