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Euroland: Purchasing managers more negative

Fri, Sep 21 2007, 09:41 GMT
by Niels-Henrik Sørensen

Danske Bank A/S

The FLASH PMIs published today fell more than expected and now signal that growth in Euroland is approaching trend. The composite PMI index fell from 57.4 to 54.5, which is the largest fall since August last year – and the lowest level for two years. The readings are consistent with GDP growth running around 0.6%q/q or 2.5% annualised growth, just above trend (see chart below).

The fall was clearly most pronounced in the service sector, and this suggests that the financial sector has probably been dealt a blow following the market turmoil over the last couple of months. However, it is also worth noting that the headline service PMI index is merely a measure of activity, and is not a weightedaverage of orders, employment, inventories, etc. as is normally the case with such business confidence indicators. This is important when interpreting the current reading, as indices of orders, inventories and employment were significantly more stable, and thus indicate a more moderate fall in overall activity.

We had actually begun to expect a stabilisation of the PMIs these last few months. The reason is that orders have picked up, and global industry is probably powering up. Furthermore, while the euro has strengthened recently, the strengthening is not much different from what we have witnessed over the last couple of years. Finally, our model on quarterly GDP growth for Euroland has picked up lately, suggesting that GDP growth will rebound in Q3 to 0.7%q/q or close to 3% annualised growth (see chart below). This is normally consistent with a composite PMI index of around 57.0. The explanation for this deviation may be that the PMIs have been quite lagging recently. Normally, they are good at capturing current GDP growth, but over the past six to nine months, the PMIs were much too positive compared to GDP growth. In the current situation, the PMIs may fall even though GDP growth has actually picked up again. Finally, the financial turmoil may also have sparked a strong fall in financial services, which could rebound in the near future.

To the ECB, who normally relies heavily on business confidence indicators in its interpretation of economic growth, this is dovish news. Historically, the ECB has been on hold when the PMIs went below the 55 level. Thus, if the readings are confirmed by other data over the coming months, the ECB may stay sidelined for a long period, even if financial markets return to normal. While this increases the risks to our base scenario in a dovish direction, our base scenario is still that GDP growth should stabilise at or a little above trend over the next few quarters. This should just keep the “economic” window for rate hikes open for the ECB until next spring. If financial markets return to normal there should thus be space enough for the ECB to raise rates a little further.

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Published on  Fri, Sep 21 2007, 09:42 GMT

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