Euro-to-Dollar Rate Hits Two-month Low after German and French Industrial Slowdown Dents Growth Outlook

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- EUR hits August lows after PMI's fall in France and Germany.

- Data points to sharp slowdown in GDP growth say economists.

- Could lead to a more cautious tone from the ECB on Thursday.

The Euro fell to a two-month low Wednesday after IHS Markit PMI data revealed a deepening slowdown in the French and German industrial sectors during October, placing the outlook for GDP growth under a spotlight.

Activity in Germany's mighty manufacturing sector grew at its slowest rate for almost three and a half years in October, with the PMI falling from 53.7 in September to 52.3.

The German services PMI fell to a five-month low of 53.6, down from 55.9 in September, as activity growth also weakened rapidly.

Both indices were adversely impacted by a decline in activity as well as new orders from both the domestic and international markets. There were a range of factors driving the downturn, according to IHS Markit.  

"Concerns towards trade wars, the threat of tariffs, Brexit uncertainty and wider geopolitical worries all weighed on business confidence at the start of the fourth quarter. Expectations among firms towards the outlook for activity over the next 12 months were the lowest for four years," IHS Markit says in a statement. 

A similar pattern was observed in the same surveys of French companies. France's manufacturing PMI declined from 52.5 to 51.2, faster than the market had anticipated, although the services PMI actually rose in October. 

The net effect of both sets of results was to push the Eurozone composite PMI, which measures activity and sentiment across all of the bloc's manufacturing and services industries, to a 25-month low of 52.7 for the current month. 

"The unexpectedly sharp decline in the Composite PMI in October leaves it pointing to the slowest pace of quarterly euro-zone GDP growth for two and a half years. The decline from 54.1 to 52.7 left it far below the consensus forecast of 53.9. Both the manufacturing and services PMIs fell sharply, while there were worrying signals in the breakdowns," says Stephen Brown, an economist at Capital Economics. 

PMI surveys measure changes in industry activity by asking respondents to rate conditions for employment, production, new orders, prices, deliveries and inventories. A number above the 50.0 level indicates industry expansion while a number below is consistent with contraction.

Markets care about the PMI data because they are an important indicator of momentum within the economy, which has a direct bearing on the rate of inflation. It is consumer price pressures that dictate where interest rates, which are the raison d'être for most moves in exchange rates, will go next.

Above: Euro-to-Dollar rate shown at hourly intervals.

The Euro-to-Dollar rate was quoted 0.47% lower at 1.1416 following the release on Wednesday and is now down 4.8% for 2018. The Euro-to-Pound rate was down 0.06% at 0.8832 and has now fallen 0.17% this year.

Above: Euro-to-Dollar rate shown at daily intervals.

"The PMI figure is compatible with a 0.3% Quarter-on-Quarter GDP growth, a deceleration from the pace seen in the first half of the year. Thanks to base effects average GDP for this year is still likely to come out at 2.0%, but the current growth pace means that next year’s GDP growth will fall back to something close to 1.5%," says Peter Houte, an economist at ING Group. 

Eurozone GDP growth slowed from a downwardly-revised 0.6% at the end of 2017 to just 0.4% in the second-quarter and, according to economists, it could have slowed further in the three months to the end of September.

Data covering the third quarter period will be released on Tuesday 30, October. GDP grew by 2.5% in 2017 overall but is forecast by the European Central Bank (ECB) to come in at just 2.1% for 2018.

"The PMIs point to a significant slowdown in the Eurozone economy at the start of Q4, primarily due to weakness in Germany and broad-based sluggishness in manufacturing. We see little to cheer about in the headlines from Markit," says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics. "To boot, executives’ outlook deteriorated sharply too."

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European Central Bank in Focus

Wednesday's data comes ahead of October's monetary policy statement from the ECB. The central bank has said it will stop buying European government bonds at the end of the year and that it could begin to raise interest rates once "through the summer of 2019". 

This would bring an end to the quantitative easing programme that has seen it hoover up as much as €80 billion per month of bonds in order to lift inflation by stimulating the economy, as well as its negative interest rate policy that has pushed the deposit rate to -0.40%.

The ECB's policy pledges are what has prevented the Euro from handing all of 2017's double-digit gain back to a resurgent U.S. Dollar this year, but those commitments are contingent on an economic performance that supports a sustained return of inflation toward the central bank's target of "close to but below 2%". 

"While new EU auto emissions standards have weighed on output in Germany in particular in recent months, it is concerning that October’s decline was driven mainly by a huge fall in the services index," says Capital Economics' Brown. "We expect the PMI to rebound before long, but amid the fiscal stand-off between Rome and Brussels as well as increasingly jittery global markets, the ECB is likely to stress caution at its meeting tomorrow."

The data, and Thursday's ECB meeting, also come amid an escalating row between Italy and the European Commission that has already dented the Euro and could have impacted activity and sentiment among companies during October.

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