The eurozone's manufacturing recovery continues to strengthen, but the accompanying price pressures are complicating the market's assessment of the European Central Bank's monetary policy path.

On Thursday, S&P Global reported that the eurozone's September manufacturing Purchasing Managers' Index (PMI) rose to 52.9, the highest level since May 2022, marking a third consecutive monthly increase and coming in above the preliminary reading of 52.7.

The pace of new order growth was the fastest since March 2022, while export orders expanded for a second consecutive month, signaling the first sustained recovery in external demand in more than four and a half years. At the same time, both input cost and output price inflation accelerated for the first time since May, and official data are expected to show eurozone inflation rising to 3.6% in September, the highest since September 2023.

The rekindling of price pressures has already left a clear mark on interest rate expectations. Market pricing currently indicates that the ECB will deliver three cumulative rate hikes by mid-2027. Chris Williamson, Chief Business Economist at S&P Global, said that demand for consumer goods continues to decline and the rising cost of living is still weighing on household spending. "Against this backdrop, the renewed acceleration in input costs and output prices is concerning, and it will further fuel speculation about additional ECB rate hikes."

Recovery Broadens as Output Index Reaches 55-Month High

The output sub-index of the September manufacturing PMI rose from 53.3 to 53.6, a 55-month high, indicating that the momentum of production expansion continues to build.

The geographic breadth of this recovery has also widened notably. All eight eurozone economies covered by the survey recorded readings above 50, marking the first full expansion in more than four years. The Netherlands led the way, followed by Ireland and Austria; Germany and Greece also posted solid expansion; while Spain, France and Italy recorded relatively moderate growth.

Business confidence strengthened accordingly, with the business confidence index rising to a seven-month high. Backlogs of orders increased for the first time since April, purchasing activity accelerated, and supplier delivery times lengthened somewhat, though the extent of delays was the mildest since February.

Investment Goods Demand Leads, with AI and Defense Spending as Core Drivers

Chris Williamson noted that the core engine of this manufacturing expansion is demand for investment goods, particularly machinery and equipment products, with output growth in related capital goods reaching its highest level since the post-COVID rebound.

He said this trend mainly reflects rising demand for artificial intelligence and defense-related equipment. In contrast, demand for consumer goods remains persistently weak, with the high cost of living still suppressing households' willingness to spend.

The labor market has also shown a positive shift. After ending more than three years of continuous workforce reductions, manufacturing employment returned to growth in August and expanded slightly further in September, indicating that the recovery has extended from the output level to hiring and capacity expansion.

Inflation Pressures Re-emerge, ECB Rate Hike Expectations Intensify

Although the recovery picture is becoming more comprehensive, the return of inflation risk is emerging as the core variable of market attention. In September, both input cost and output price inflation accelerated for the first time since May, although the increases remained below the peak levels seen earlier in the year.

Official inflation data are expected to be released on Friday, with the market anticipating that eurozone inflation will rise from 3.2% in August to 3.6% in September, which, if realized, would mark a new high since September 2023.

Market pricing for the ECB's policy path has adjusted accordingly, with three rate hikes now expected by mid-2027. The parallel pattern of manufacturing recovery and inflation pressures places the ECB in a more delicate trade-off regarding its policy stance.