Manufacturing activity across the euro area showed one of the strongest expansions in years in February, pointing to a tentative recovery in industrial demand and output.
However, the surge in energy prices and renewed geopolitical risk following military strikes on Iran threaten to sap momentum and complicate the broader economic picture.
According to the latest HCOB Eurozone Manufacturing Purchasing Managers’ Index compiled by S&P Global, the headline manufacturing PMI climbed to 50.8 in February from 49.5 in January, marking the best performance since June 2020 and the first reading above the 50 expansion threshold since August. A reading above 50.0 signals growth, a meaningful shift after months of stagnation and contraction.
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The improvement was driven by the strongest rise in new orders since April 2022, suggesting that both domestic and some external demand conditions are stabilizing. Factory output expanded for the 11th time in 12 months and hit a six-month high. Germany—the bloc’s industrial engine—returned to growth after years of subdued activity, while Italy, the Netherlands, Ireland, and Greece also showed solid expansion. France posted modest growth, and export orders, though still weak, contracted at the slowest rate in months.
However, the rebound comes with pronounced cost pressures. Input costs rose at the fastest rate in more than three years, with firms citing sharply higher energy prices among the main drivers. Manufacturers responded by raising selling prices at the fastest rate since March 2023, underscoring how cost inflation is squeezing margins even as production increases.
Labor markets in manufacturing remain cautious: employment levels continued to trend down, albeit at a slower pace, reflecting firms’ reluctance to scale staffing ahead of a more durable recovery.
Conflict-Driven Energy Shock Risks Undercutting Growth
The manufacturing improvement may be at risk of a fresh setback due to spiraling energy costs tied to the Middle East conflict. Last weekend’s coordinated military strikes on Iran by the United States and Israel have rattled energy markets and raised the specter of a prolonged energy crisis. Brent crude prices surged sharply—up more than 8–10% at times—after the conflict disrupted tanker flows through the vital Brent crude trading routes and fears mounted over the closure of the Strait of Hormuz, which sees about a fifth of global oil traffic.
Analysts at banks, including UBS, have flagged that the Strait of Hormuz chokepoint, through which an estimated 20% of world oil supplies flow, could elevate crude prices even further if navigational risks persist or escalate.
Rising energy costs flow directly through to industrial producers in the euro zone, where energy intensity is relatively high in chemicals, metals, and heavy machinery sectors. Even if current donor countries attempt modest production increases, supply constraints near the Gulf and heightened insurance costs for shipping mean that delivered energy remains expensive.
European gas markets have also reacted. LNG futures in the region jumped amid reports of pipeline and facility disruptions, adding to industrial input cost pressures.
The energy shock risks reigniting price pressures at both producer and consumer levels. While headline inflation in the euro area hovered near ECB targets prior to February, a sustained spike in energy prices complicates the inflation outlook and the monetary policy path. Higher fuel costs for factories, freight, and logistics feed into broader goods price indices, making it harder for the European Central Bank to contemplate interest-rate cuts without risking inflation overshooting.
While business confidence across the region climbed to a four-year high in the PMI survey, reflecting optimism about the near-term demand rebound, that confidence now faces a significant test as geopolitical uncertainty, energy market volatility, and potential supply-chain bottlenecks weigh on sentiment.
The euro-area manufacturing sector may have broken its longest slump, but its ability to sustain momentum may likely be determined by how energy prices evolve and whether the broader conflict in the Middle East expands or is quickly contained. A prolonged energy shock, with oil prices maintaining their elevated levels or continuing to climb, could undercut demand, erode margins, and slow hiring plans, potentially reversing some of the hard-won gains noted in February’s PMI data.