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U.S. service sector gains, ECB cuts rates, and labor market challenges persist

U.S. service sector gains, ECB cuts rates

Yesterday, the U.S. ISM Services PMI showed a notable increase, rising from 49.4 to 53.8 in May, which significantly exceeded expectations set at 51.0. This substantial rise reflects a stronger than anticipated performance in the service sector, indicating that the economy is gaining momentum. The details within the report reveal that economic activity and production saw a considerable surge, jumping from 50.9 to 61.2. This level of growth is the highest recorded since November 2022, signaling a robust rebound in these areas. Such a sharp increase suggests that businesses are experiencing higher demand, which in turn is driving production and overall economic activity.

Additionally, new orders rose from 52.2 to 54.1, indicating that future activity may continue to be strong as companies receive more orders. This uptick in new orders is a positive sign for sustained economic growth, as it suggests that businesses are confident in the demand for their services. Employment figures also showed improvement, moving from 45.9 to 47.1. While this is still below the neutral threshold of 50, the increase indicates that the service sector is beginning to hire more workers, albeit at a modest pace.

However, the price index fell from 59.2 to 58.1, which could suggest a reduction in inflationary pressures. This decrease in prices might be a result of easing supply chain issues or other cost pressures, providing some relief to businesses and consumers alike.

Today's U.S. labor market data did not meet expectations once again, reflecting ongoing challenges in the employment landscape. The number of new jobless claims rose by 8,000 to 229,000 in the week ending May 25, surpassing the anticipated figure of 215,000. This increase suggests that more individuals are filing for unemployment benefits, which may indicate underlying issues in the labor market. It could be a sign of layoffs in certain sectors or challenges that businesses are facing, leading them to reduce their workforce. This uptick in jobless claims can also have broader economic implications, potentially impacting consumer spending and confidence if people become more concerned about job stability.

However, the four-week moving average of initial claims, which smooths out weekly volatility, decreased by 750 to 222,000. This decline in the moving average suggests some stabilization in the labor market, as it indicates that the overall trend in jobless claims is improving slightly. Despite the weekly rise, the decrease in the moving average may signal that the labor market is not deteriorating as quickly as weekly figures might suggest. It offers a more stable view of the employment situation, providing some hope that the labor market could be finding its footing.

As expected, the European Central Bank (ECB) initiated a cycle of monetary easing today by reducing the deposit rate by 25 basis points to 3.75%. This move marks a significant shift in the ECB's policy stance, aimed at stimulating economic growth in the Eurozone. Following this cut, the main refinancing rate now stands at 4.25%, the deposit rate at 3.75%, and the marginal lending rate at 4.50%. This suite of rate adjustments is designed to make borrowing cheaper and to encourage lending and investment across the Eurozone. Lower interest rates can help businesses and consumers by reducing the cost of loans, thereby fostering economic activity.

However, ECB policymakers have expressed caution about committing to a specific path for future interest rates. They emphasize that despite the recent rate cuts, inflation remains persistently high. This cautious approach highlights the balancing act that central banks must perform: stimulating the economy while keeping inflation in check. The ECB's decision to lower rates reflects concerns about the economic outlook and the need to provide additional support to ensure recovery, but they remain vigilant about the risk of rising prices.

In its latest forecasts, the ECB projects that economic growth will accelerate to 0.9% in 2024, 1.4% in 2025, and 1.6% in 2026. These growth projections indicate a gradually improving economic outlook, suggesting that the Eurozone economy is expected to gain strength over the next few years. This positive growth trajectory is likely to be driven by a combination of factors, including improved consumer confidence, increased investment, and supportive monetary policies.

Alongside growth forecasts, the ECB expects inflation to average 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026. These inflation projections indicate that while inflationary pressures are expected to moderate, they will still be present in the coming years. Both the headline and core inflation forecasts for 2024 and 2025 have been revised upwards, reflecting concerns that inflation may remain more entrenched than previously anticipated. Although inflation in the Eurozone is approaching the central bank's 2.0% target, persistently high inflation in the services sector remains a concern.

In May, inflation in this sector stayed above 4.0% annually, raising expectations that the ECB might refrain from an aggressive easing cycle. The high inflation in services suggests that price pressures are still strong in parts of the economy, which could complicate the ECB's efforts to stimulate growth without exacerbating inflation.

Regarding the euro exchange rate, the EUR/USD pair is expected to continue its upward trend. The recent ECB rate cut has already been priced into the market, and the timing of any future cuts remains uncertain. After a series of weak economic data from the U.S., market participants are now focusing on the potential for the Federal Reserve to lower interest rates. Such a move by the Fed could further support the euro, as lower U.S. rates would make the dollar less attractive to investors.

On the EUR/USD chart, there hasn't been a dramatic surge in the euro's value against the dollar. However, if upcoming U.S. data continues to disappoint, it seems likely that the euro will eventually break through the 1.09 level on the EUR/USD pair. This potential breakthrough would signal increased confidence in the euro, driven by expectations of divergent monetary policies between the ECB and the Fed. As markets adjust to these expectations, the euro could see further gains against the dollar, reflecting a shift in investor sentiment and positioning.

eurusd chart
EUR/USD, daily chart, MetaTrader, after ECB decision, 06.06.2024

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