Europe's economy hit hard as energy price shock stifles demand
The eurozone’s economy contracted sharply in May, with the Flash Euro Zone Composite PMI hitting 47.5—the lowest since October 2023—as surging energy costs and war-driven inflation stifled demand, accelerated layoffs, and pushed services activity to a two-year low. The European Central Bank (ECB) remains poised to raise interest rates in June to combat inflation, despite mixed signals on whether price pressures are becoming entrenched.
Economic activity in the eurozone shrank at its fastest pace in over two-and-a-half years in May, according to S&P Global’s Flash Euro Zone Composite PMI, which fell to 47.5 from 48.8 in April. The reading marked the second consecutive month of contraction in the bloc’s private sector, signaling a heightened risk of a recession in the second quarter of 2025. Services activity, the dominant driver of the eurozone economy, contracted at the steepest rate since February 2021, while new orders dropped at their fastest pace in 18 months. Germany, Europe’s largest economy, saw private sector activity contract for a second straight month, with firms citing soaring fuel and energy costs as the primary reason for reduced output. France’s headline PMI also hit a five-and-a-half-year low, reflecting broader economic uncertainty. Outside the eurozone, Britain experienced its most widespread decline in activity in over a year, exacerbated by the Iran war’s economic fallout and domestic political instability. Input price inflation surged to a three-and-a-half-year high, with output prices rising at their fastest pace in 38 months, though only marginally faster than April. S&P Global warned inflation could remain near 4% in the coming months, reinforcing the European Central Bank’s (ECB) stance on tighter monetary policy. While the ECB left rates unchanged in May, policymakers, including Olli Rehn, signaled a potential 25-basis-point hike in June to preserve credibility amid war-driven fuel cost spikes. The labor market further deteriorated, with eurozone companies cutting headcounts for a fifth consecutive month—the fastest pace since November 2020 (excluding the pandemic). The ECB’s April inflation data showed prices rising at 3.0%, above its 2.0% target, though officials remain cautious about sustained inflation. Analysts, such as Andrew Kenningham at Capital Economics, argue the data strengthens the case for a rate hike, despite recession risks. The decline in export orders, including intra-eurozone trade, was the steepest since January 2025, partly due to supply chain disruptions from the U.S.-Israeli war with Iran and the closure of the Strait of Hormuz. The manufacturing PMI fell to 51.4, below expectations, though supply delays may have artificially elevated some readings. Consumer confidence is expected to weaken further, adding to the downward pressure on economic growth.
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