Europe’s economy is not behaving the way forecasters expected. After a fresh surge in energy prices, most predictions pointed to a slowdown. Instead, business activity across the eurozone sped up in September to its strongest level in more than three years.
The composite purchasing managers’ index rose to 53.1 from 52.0 in August, according to S&P Global’s flash survey. Anything above 50 signals expansion. Economists had expected a dip to 51.7, and even the most optimistic forecast, 52.6, fell short of the result.
A broad-based pickup
The strength was not confined to one corner of the economy. Manufacturing and services both grew. New orders rose at their fastest rate in more than four years, and companies hired more staff to cope with demand.
Germany, which has spent much of recent years dealing with weak industry and expensive energy, reported solid growth. Higher defence spending, investment linked to artificial intelligence and firmer demand have helped its factories. France saw activity expand at its quickest pace in just over two years, led by services.
S&P Global said the survey pointed to quarterly GDP growth of roughly 0.4 per cent. That comes with a caveat. PMIs are surveys of business sentiment and activity, not official output data.
Still, the reading fits a pattern. The European Central Bank raised its own growth forecasts this month, to 0.9 per cent for 2026 and 1.4 per cent for 2027, citing more resilience than it had anticipated.
The inflation problem
Resilience is welcome, but it makes the ECB’s job harder. Firms in the survey reported a steep rise in input costs, tied to higher energy prices linked to the conflict in the Middle East. Crucially, many were able to pass at least some of those costs on to customers, and the survey’s price indicators strengthened alongside output.
That matters because inflation is already too high. Eurostat’s latest figures put annual eurozone inflation at 3.2 per cent in August, up from 2.9 per cent in July and well above the ECB’s 2 per cent goal. Energy alone added about 1.3 percentage points to the headline figure.
The central bank moved on 10 September, raising all three of its main interest rates by 25 basis points and lifting the deposit rate to 2.50 per cent. It was the second increase this year. Its projections show inflation averaging 3.0 per cent in 2026 and 2.5 per cent in 2027, and returning to 2.1 per cent only in 2028. That is a longer road back to target than policymakers once hoped.
An awkward mix for policymakers
Normally, an energy price shock gives central bankers a dilemma. Higher prices argue for tighter policy, but a weakening economy argues for patience. If growth slumps, the ECB can more easily look through a temporary spike in inflation.
This time, growth is not slumping. Demand is strong enough that companies can raise prices, which makes it harder to treat the inflation as a passing event. Markets have taken note. Traders are pricing in three more ECB rate rises by the end of June 2027, although policymakers stress that they will decide meeting by meeting rather than follow a fixed path.
Reasons for caution
None of this means the outlook is clear. Higher energy bills eat into household budgets and raise costs for industry. Interest rate rises also work with a delay, so the full effect of earlier moves has probably not yet reached the economy. A prolonged energy shock could still drag on growth later, even if September’s numbers look strong.
For now, though, the picture is unusual. The eurozone has absorbed an energy shock without the contraction many predicted, and that resilience removes one of the strongest arguments against further tightening.
The question facing the ECB has shifted. It is no longer whether Europe can withstand higher energy costs. It is whether an economy that keeps growing can bring inflation back to 2 per cent without more increases in interest rates.
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