Business activity in the eurozone unexpectedly contracted for the first time since late 2024, driven by a significant downturn in the services sector. This decline is attributed to pressures on consumers stemming from the conflict involving Iran. According to the latest data from S&P Global, the Eurozone Composite Purchasing Managers' Index (PMI) fell sharply to 48.6 in April from 50.7 in March. This marks the first time the index has dropped below the 50-point threshold that separates expansion from contraction since the end of 2024, surprising analysts who had forecast only a slight decline to 50.1.

While Germany's industrial sector demonstrated some resilience under pressure, the core services sector, which is vital for supporting the economy, experienced a steep decline. France's performance was notably distinct; although its services sector also faced contraction, its manufacturing sector conversely achieved its strongest growth since 2022. Price pressures continued to climb across the eurozone.

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, stated on Thursday, "The eurozone is confronting a deepening economic downturn triggered by the Middle East conflict, presenting significant challenges for policymakers. Furthermore, increasingly widespread supply shortages could further restrain economic growth and exert greater upward pressure on prices in the coming weeks."

Faced with a "stagflationary" scenario of simultaneous inflation and recessionary pressures, the European Central Bank's (ECB) policy options are severely constrained. Although inflation remains significantly above the 2% target and the labor market is showing the first signs of layoffs since 2024, the unexpected contraction in economic activity makes it highly probable that policymakers will keep interest rates unchanged this month. This would allow more time to assess the persistence of price shocks. However, due to lingering market concerns about inflation stickiness driven by future energy costs, traders widely anticipate the possibility of two further rate hikes before the end of the year.

Rising energy costs, which are fueling inflation, are also pressuring output that was previously expected to gain momentum before the conflict erupted. Defense and infrastructure expenditures amounting to hundreds of billions of euros in countries like Germany will help cushion the impact. As prices for commodities like gasoline surge, governments in some nations have begun intervening to provide assistance.

The ECB, in its March projections, forecast GDP growth of 0.9% in 2026 and 1.3% in 2027. However, officials have recently indicated that the eurozone's situation lies somewhere between these baseline forecasts and a more adverse scenario assuming a prolonged conflict and weaker growth.

Williamson warned that pessimism within the business community has pushed confidence to its lowest level since late 2022. Data released on Wednesday also indicated that consumer confidence has been similarly affected. He also cautioned against excessive optimism regarding the manufacturing sector's relatively better performance. Growth in this sector has a "sting in its tail, as companies rush to purchase supplies ahead of further price increases or shortages, with goods demand being supported by inventory rebuilding efforts."

Regarding inflation, Williamson noted that increases in input costs and selling prices are not only a reaction to rising energy costs but also reflect broad-based increases in commodity prices and a mismatch between demand and constrained supply. "Excluding the pandemic period, this is the largest surge in cost pressures we have recorded since 2000," he stated.

PMIs are closely watched by markets because they are typically released early in the month and are adept at revealing economic trends and turning points. However, because PMIs measure the breadth rather than the depth of changes in output, business surveys can sometimes be difficult to correlate directly with quarterly GDP figures. While the composite reading for the eurozone has fallen below 50, the corresponding indicator for the United States is expected to remain above that threshold.