(Bloomberg) -- Euro-area private-sector business activity reached its highest level in a year — suggesting the region’s economic rebound is taking hold.

S&P Global’s purchasing managers’ index rose to 52.3 in May — exceeding analyst forecasts and coming in above the 50 threshold that signals growth for a third month.

“This looks as good as it could be,” said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank. “The euro zone’s economy is gathering further strength. Encouragingly, new orders are growing at a healthy rate while the companies’ confidence is reflected by a steady hiring pace.”

German bonds weakened as money markets pared wagers on the extent of interest-rate reductions by the European Central Bank, which are expected to begin next month. The two-year yield, among the most sensitive to monetary policy, rose five basis points to 3.06% — its highest since November.

Just 60 basis points of cuts are priced this year — equivalent to two quarter-point cuts and a 40% chance of a third. Three were virtually fully priced as recently as last week.

There was good news for Europe’s biggest economy as Germany’s PMI reading topped expectations and included a much better contribution from manufacturing. France, though, was unexpectedly dragged back into contraction territory as services underperformed.

“While people love to compare the performance of economies, finger-pointing to the possible weaknesses and strengths, the good news here is that overall, both economies move in tandem,” de la Rubia said. “This means that there are good chances for France to catch up eventually in the services sector, which would put euro-zone growth on a sounder footing.”

What Bloomberg Economics Says...

“The euro-area composite PMI is good news all around. Inflation is decelerating, reviving real incomes, and GDP growth is likely to remain buoyant in 2Q24. That will allow the ECB to begin lowering interest rates in June and should enable it to continue cutting in the second half of the year.”

—David Powell, economist. Click here for full REACT

The outlook is perking up for the 20-nation bloc after a recession in the second half of last year. With inflation nearing the 2% target and the ECB about to begin lowering rates, the European Commission said last week that the continent remains on course for a soft landing.

ECB Executive Board member Isabel Schnabel momentum has been building recently, adding to optimism that the economy has left the worst of its crisis behind.

“We’re currently seeing a slight revival of the economy in the euro area,” she told German broadcaster ARD on Wednesday. “At the same time, inflation continues to retreat. Therefore, there’s reason for hope that we’ll succeed in returning to price stability without experiencing a recession.”

The growth, though, masks a prolonged slump in the industrial sector - particularly in Germany, which has suffered from weak global demand and the spike in energy prices that followed Russia’s invasion of Ukraine.

The factory malaise may be slowly coming to an end, according to S&P Global, which predicted the euro area may record growth in gross domestic product of 0.3% in this quarter - matching the pace for the previous three months.

There were warning signs for consumer prices, however, that could slow the speed at which the ECB reduces rates this year. S&P called the services sector — the key focus for policymakers in Frankfurt — the “principal source of inflationary pressure,” with input costs rising rapidly.

ECB Vice President Luis de Guindos said price growth will probably fluctuate in the short term before converging sustainably to 2% in 2025. While a quarter-point cut next month looks reasonable, he urged caution beyond that. 

“There is a huge degree of uncertainty,” Guindos said in an interview with Oberösterreichische Nachrichten published Thursday. “We have made no decisions on the number of interest rate cuts or on their size. We will see how economic data evolve.”

Separate data showed the UK’s recovery lost some momentum in May as activity and price pressures in the services sector started to fade. US figures due later are set to show continued growth.

PMIs are closely watched by markets as they arrive early in the month and are good at revealing trends and turning points in an economy. A measure of breadth of changes in output rather than depth, business surveys can sometimes be difficult to map directly to quarterly GDP.

--With assistance from Mark Evans, Joel Rinneby and Alice Gledhill.

(Updates with market reaction, Bloomberg Economics, UK reading starting in fourth paragraph.)

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