Europe's Economy Just Grew at Its Fastest Pace Since 2023, Two Weeks After the ECB Raised Rates Again

The surprise in Europe's numbers

When a central bank raises interest rates, the economy is supposed to slow. Borrowing gets more expensive, businesses delay projects and consumers spend less.

Europe did the opposite. The flash HCOB eurozone composite PMI, compiled by S&P Global, jumped to 53.1 in September. That's up from 52.0 in August, well above the 51.7 economists expected, and the strongest reading since April 2023.

It came just days after the European Central Bank raised its deposit rate to 2.50%, its second hike this year.

What the PMI is and why it matters

A purchasing managers' index surveys thousands of companies each month. It asks a simple question: is business better or worse than last month?

• Above 50: the economy is growing
• Below 50: it's shrinking

PMIs come out weeks before official GDP figures, so markets treat them as an early read on the economy.

What September showed

• Composite PMI: 53.1, a nearly 3.5-year high
• Services: 53.0, a 10-month high
• Manufacturing: 52.7, with factory output at a 55-month high
• New orders: fastest growth since May 2022, and backlogs rose for the first time since June 2022
• Germany: growing for a third straight month, at its fastest pace in almost a year
• France: back to growth for the first time in 10 months
• Prices: still high by historical standards, with firms passing some energy costs to customers

Why Europe is holding up

Three things are helping:

1. Defence and infrastructure spending. European governments, led by Germany, are spending heavily on defence and public works. That supports factories and construction.
2. Exports. New export orders rose again in September.
3. Rates are still low in real terms. Even at 2.50%, the ECB's deposit rate sits below inflation, which ECB staff project at 3.0% this year. When inflation is above the interest rate, borrowing is still cheap in real terms.

Why this raises the odds of another hike

The ECB's job is to bring inflation back to 2%. Its own staff expect headline inflation of 3.0% in 2026 and 2.5% in 2027. Core inflation, excluding food and energy, is projected at 2.5% and 2.6%.

A fast-growing economy makes it harder for inflation to fall. "The resilience of economic growth amid geopolitical issues and rising prices would likely embolden the ECB to hike interest rates again before the end of the year," said Chris Williamson, chief business economist at S&P Global Market Intelligence.

The ECB says it will decide meeting by meeting.

What it means for investors

European stocks. A growing economy helps cyclical sectors such as industrials, banks and materials. Higher rates also help European banks' lending margins, as long as loan losses stay low. The risk is valuation: German, French and Italian indexes hit records this year.

The euro. Higher ECB rates usually support a currency, but the Fed is hiking too. On September 23, the euro slipped about 0.5% to $1.1389 as US yields jumped. The rate gap between the US and Europe drives the euro more than growth.

European bonds. Stronger growth and possible hikes push yields up and bond prices down. Short-term bond funds carry less of that risk.

How to get exposure to Europe

• US investors: broad Europe ETFs such as Vanguard FTSE Europe (VGK) or iShares Core MSCI Europe (IEUR).
• Canadian investors: Canadian-listed Europe ETFs from Vanguard, iShares or BMO, in Canadian dollars.
• Currency-hedged versions remove most of the euro and pound effect, so you get the stock returns without the currency swings. See Currency-Hedged vs Unhedged ETFs.

Most global index funds already hold 10% to 15% in Europe, so check what you own before adding more.

The honest uncertainty

One strong PMI isn't a trend. PMI surveys measure how many firms are growing, not by how much. An energy-price spike or a slowdown in US demand could reverse it quickly. But for now, Europe's economy looks stronger than its central bank feared, and that probably means rates stay higher for longer.

Frequently asked questions