There is a big divergence between hard and soft data in the euro area at the moment (see charts next page). Although not clear cut, it does suggest that soft data – such as euro PMI – may be too downbeat and could surprise on the upside in coming months.
Euro industrial production was released today and showed surprising strength, rising 0.6% m/m for the second time in a row. This is much stronger than indicated by soft data such as PMI, ZEW, EU sentiment etc.
If unrevised, it points to positive euro area growth already in Q3. Our hard data model now points to a rise in GDP of 0.3% q/q in Q3. However, our soft data model points to -0.4% in q/q. This is a very unusual difference as the models normally point to similar growth rates.
The divergence also shows up in the German data for production and orders. Production has been strong in recent months whereas factory orders have been weak.
So, which of them is right? Well, hard data of course is hard data and that is what feeds into the GDP. However, given the weakness in much of the soft data, it does raise a question mark with regard to the reliability of the hard data at the moment.
Overall there are three possible outcomes going forward:
1. The hard data will be revised.
2. We will see a nose dive in industrial production in coming months, putting it more in line with soft data.
3. Sentiment data is too negative and will rebound strongly in coming months.
Since the rise in production is seen in pretty much all euro countries, it would seem that there is a common factor in play and that revisions are not so likely. So, either the strength is genuine, or it reflects technical factors (problems with seasonal adjustment etc.) that provide a temporary positive effect now and a subsequent decline in coming months. The divergence between orders and production in Germany points to stock building and this does indeed point to a decline in production in coming months.
What is the chance that the soft data is too negative and that we will see a rebound? Actually, looking at other hard data from the demand side rather than the output side could suggest that sentiment may be too negative. Exports have been holding up fairly well so far. And retail sales have stabilised lately after a period of steep decline. The weakness in PMI is thus not to be found in either exports or consumer demand.
The data currently does not paint a very consistent picture, adding to the uncertainty about where the euro economy is at the moment. Our base case is still that we will start to see an only gradual rise in PMIs over the coming months and a slightly negative Q3 GDP reading. We also expect industrial production to fall back.
However, the recent hard data does tilt risks towards the possibility of sentiment being too downbeat relative to reality and hence we could see upward surprises in PMIs in coming months. This would underpin risk sentiment and performance of risk assets.