Recent PMI data from France and Germany shows that Europe’s largest economies are holding strong. This supports the European Central Bank’s (ECB) choice to pause interest rate changes throughout the summer. The stability is reassuring amid concerns about stagflation, as the euro area’s economy has improved compared to the fourth quarter of last year. While economic slowdown persists, it is not as prominent in discussions as one might expect. In August, France faced increased inflation pressure, with input costs rising at the fastest rate since May. This trend affected various sectors, mainly due to wage increases and higher raw material costs. As a result, French companies raised their prices for the third month in a row. Similarly, in Germany, August saw a rise in both input and output cost inflation, following a slowdown in July. The service sector drove this increase, marking the highest input prices since March, while output price inflation reached a three-month peak.

Implications of Rising Price Pressures

These trends suggest a rise in price pressures, making the ECB cautious after summer. The ECB’s decision to pause on rate changes appears justified and may extend into the fourth quarter, with markets expecting only slight rate cuts by the end of the year. The latest August PMI data from France and Germany confirms economic resilience, supporting the ECB’s decision to hold interest rates steady through the summer. Germany’s composite PMI stands at 51.2, while France’s is at 50.8, placing both in the expansion zone. This strength reinforces the case for the ECB to stay cautious. More importantly, the reports show concerning inflationary pressures returning, with input costs and selling prices rising sharply. This corresponds with the Eurozone Harmonised Index of Consumer Prices for July 2025, which is at 2.5%, still above the ECB’s 2% target. These price increases will make the central bank wary of lowering rates too quickly.

Market Reactions to Inflationary Pressures

The market is reacting, with expectations for interest rate cuts by the end of 2025 fading. Overnight Index Swaps now suggest only about 10 basis points of easing by year-end, a sharp shift from earlier predictions in the second quarter. This indicates that traders are moving away from bets on a 2025 rate cut. For derivative traders, this means that positions betting on lower rates, like long positions in Euribor futures, are increasingly at risk. The smarter strategy in the coming weeks is to prepare for a prolonged pause from the ECB, which may last the rest of the year. This could involve selling short-term interest rate futures to hedge against any sudden rate cuts. Given the uncertainty surrounding the ECB’s next move, we can expect increased volatility for options linked to the October and December policy meetings. This opens up opportunities for strategies that can benefit from a stable rate environment while protecting against unexpected changes. Betting on stable rates seems to be the main focus right now. We should remember the economic resilience shown during the winter of 2024-2025, which helped the Eurozone avoid the feared recession. This underlying strength, together with ongoing inflation, suggests that the ECB’s “higher for longer” approach is well-founded. Any derivative strategies should now align with this reality. Create your live VT Markets account and start trading now.

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