The eurozone’s economic engine is barely ticking over rather than roaring, with private sector activity showing only the slimmest expansion in February, just enough to stay in growth territory.

Meanwhile, inflationary pressures are heating up again, leaving the European Central Bank (ECB) in a policy conundrum ahead of its anticipated rate cut this week.

A fragile recovery with rising price pressures

The eurozone's Composite Purchasing Managers’ Index (PMI), a key measure of private sector activity, remained unchanged at 50.2 in February, the same as in January, according to flash estimates from S&P Global.

A reading above 50 signals expansion, but with the index hovering barely above that threshold, the region's recovery remains fragile.

Services activity, which has been the backbone of the eurozone economy, lost momentum.

The Services PMI fell to 50.6 from January’s 51.3, slightly missing expectations of 50.7.

The slowdown was driven by a renewed decline in new business, marking the first drop in demand since November.

Weakness in foreign demand also contributed, although the decline was the mildest in seven months.

Inflationary pressures remained stubbornly high.

Service providers increased prices at the fastest rate in ten months, as firms continued to pass on higher input costs to customers.

Overall, input cost inflation accelerated to its sharpest pace in nearly two years, a concerning signal for the ECB.

"With no sign of input cost inflation abating, it is understandable that there are some voices in the ECB who would like to discuss a pause in rate cuts at the next meeting," said Dr. Cyrus de la Rubia, Chief Economist at Hamburg Commercial Bank.

France and Germany diverge as Spain and Italy outperform

A closer look at individual countries reveals a stark contrast in economic performance across the eurozone’s largest economies.

France’s private sector remains deep in contraction, with its Composite PMI falling to 45.1 from 47.6.

Services activity declined sharply, with the services index plunging to 45.3 from 48.2.

In Germany, activity expanded, but only marginally. The Composite PMI dipped slightly to 50.4 from 50.5, missing expectations.

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The country’s services sector also slowed, with the Services PMI declining from 52.5 to 51.1, well below forecasts.

Business confidence is showing signs of fragility, with companies citing political uncertainty in France and Germany and a global economic backdrop that does little to support consumer spending.

"This may be the result of an unsolved political crisis in France, while in Germany the elections may raise hope for a stable government to be formed soon," de la Rubia said, highlighting the sharp divergence in economic performance.

The resilience, however, came from southern Europe.

Spain’s Services PMI jumped from 54.9 to 56.2, exceeding expectations, while Italy’s services sector also posted stronger-than-expected growth, rising from 50.4 to 53.

ECB dilemma: Cutting rates in an inflationary environment?

The ECB is widely expected to cut its key interest rates by 25 basis points to 2.5% this week.

Yet, the stubborn persistence of inflationary pressures complicates the path forward.

Service providers still have pricing power, as is evident from the rise in selling price inflation compared to January.

“Overall, the picture is not bleak, but fragile,” de la Rubia said.

Preliminary data released Tuesday by Eurostat showed that price pressures in the eurozone remained stronger than expected in February.

Headline inflation eased to 2.4% from 2.5%, slightly above forecasts of 2.3%, while core inflation - which excludes volatile food and energy prices - inched down to 2.6%, remaining well above the target.

This persistent underlying inflation adds to the ECB’s dilemma, as policymakers weigh rate cuts against lingering price pressures.

Market reaction: Euro and stocks rally

Despite the subdued PMI figures, markets reacted positively.

The euro strengthened further, climbing to 1.0715 against the US dollar, up 0.8%, fully recovering losses since Donald Trump's election victory in November 2024.

European stocks also rebounded sharply, reversing Tuesday’s declines.

The Euro STOXX 50 surged 2.2% to 5,505 points by mid-morning trading, while Germany’s DAX outperformed, jumping 3.2%.

Banking and industrial stocks led the gains, with Deutsche Bank AG soaring over 9%, BASF SE up 7.6%, and Siemens AG rising 7.4%.

Deutsche Telekom AG and Linde plc lagged, slipping 1.6% and 1.5%, respectively.