ECONOMICS COMMENTARY — Jul 24, 2023
Eurozone flash PMI signals cooling inflation amid rising recession risks
Eurozone business output fell at the fastest rate for eight months in July, according to the latest HCOB flash PMI survey data produced by S&P Global, marking a weak start to the third quarter.
Deteriorating forward-looking indicators such as future output expectations and new order inflows also point to the likelihood of the downturn deepening in coming months, prompting companies to pull back on hiring.
Price pressures meanwhile moderated further, with average selling prices rising at the slowest rate for almost two-and-a-half years. Prices charged by manufacturers fell at a rate not seen since the height of the global financial crisis in 2009 amid slumping demand, while service sector selling price inflation cooled to a 21-month low. Measured overall, the PMI's gauge of selling prices for goods and services is indicative of consumer price inflation continuing to cool at an encouraging pace in the months ahead.
While markets have been pricing in at least one further interest rate hike by the European Central Bank, the falling output signalled by the PMI in conjunction with the cooling of price pressures will add to speculation that rates may soon peak or be put on hold pending further data signals.
Output falls at faster rate
The seasonally adjusted HCOB Flash Eurozone Composite PMI Output Index, based on approximately 85% of usual survey responses, dropped from 49.9 in June to 48.9 in July, its lowest since last November. The latest reading signals a second successive monthly fall in output in volume terms after five months of continual expansion, the rate of contraction gathering pace from the marginal decline recorded at the end of the second quarter.
Demand conditions meanwhile worsened across the board. New business inflows fell at an increasingly severe rate in July, dropping to the greatest extent since last November. The decline in new orders notably exceeded that of output to a degree not seen since February 2009, hinting that companies will seek to reduce output further in the coming months in response to the worsening demand environment.
A steepening loss of new orders in the goods-producing sector, which saw one of the steepest declines since 2009, was accompanied by the first downturn in new orders for services for seven months.
Hiring hit by concerns over excess operating capacity and lower optimism
The dearth of new orders meant backlogs of work fell at an increased rate as companies often relied on previously placed orders to support current operating levels. If the initial COVID-19 lockdown months are excluded, the latest drop in backlogs of work was the largest recorded since February 2013, and in the case of manufacturing the steepest since 2009. Service sector backlogs fell in July for the first time in six months.
The deteriorating order book situation dented business confidence, pushing companies' expectations of output levels in the coming year to their lowest since last November. The latest decline pushed sentiment further from February's recent peak and increasingly below the survey's long-run average to thereby signal subdued optimism by historical standards. Confidence deteriorated in both manufacturing and services, albeit with the latter exhibiting greater resilience.
With confidence waning and the demand environment worsening, companies pulled back on hiring in July, leading to the smallest monthly increase in employment since February 2021. The overall increase was only modest, reflecting a second successive month of manufacturing net job losses and the smallest gain in service sector jobs for five months, the rate of increase in the latter having slowed sharply from the historically elevated rates recorded during the second quarter.
Manufacturers also adjusted to lower production requirements by further reducing their inventory levels. Stocks of finished goods were allowed to fall for a third month in a row and stocks of inputs fell for a sixth straight month, the latter declining at the sharpest rate since December 2012. July also saw the largest reduction in input buying by factories since May 2009 barring only the COVID-19 lockdowns of early-2020. This reduced purchasing of inputs by manufacturers took pressure off supply chains, which in turn helped supplier delivery times continue to improve at a rate not seen since 2009.
Prices rise at slower rates
Inflationary pressures meanwhile moderated in July, with gathering deflation in manufacturing compounded by slower service sector inflation. Measured across both sectors, the rate of input cost inflation fell again in July, down for a tenth straight month to its lowest since November 2020 and dropping further below the survey's long-run average.
Average prices charged for goods and services meanwhile rose at the slowest rate for 29 months. As such, the survey data are consistent with consumer price inflation continuing to cool from the 5.5% annual rate seen in June, dropping closer to 3% before the end of the year.
In manufacturing, falling demand for inputs, combined with improved supply, led to further discounting in supply chains. Over the 25-year survey history, only the six-month period to May 2009 has seen a steeper rate of decline in average factory input prices than witnessed in July. Lower costs fed through to lower manufacturing selling prices, which dropped for a third successive month and at the sharpest pace since September 2009.
While service sector input costs continued to rise at a rate well above the survey's long-run average, buoyed in particular by upward wage pressures, the rate of increase slowed for a fifth consecutive month, edging down to the lowest since May 2021. Average prices charged for services also rose at a reduced pace, the rate of inflation at its lowest since October 2021.
National trends
Looking at growth across the euro area, France reported an especially steep downturn in output, which fell for a second successive month and at the sharpest rate since November 2020. If the pandemic is excluded, the decline was the steepest since May 2013. Rates of contraction accelerated in both manufacturing and services, albeit with the former suffering the steeper rate of decline.
However, Germany also fell into contraction, as output dropped for the first time since January and at the sharpest rate since last November. An especially steep fall in German factory output, which deteriorated at a rate not seen since 2009 if pandemic lockdown months are excluded, was accompanied by a sharp slowing in services activity growth, which was in turn driven by a steep loss of new orders for services.
The rest of the region as a whole meanwhile eked out only very modest growth for a second successive month, representing the weakest performance so far this year, reflecting an increasingly severe downturn in manufacturing and weaker demand growth for services.
Chris Williamson, Chief Business Economist, S&P Global Market Intelligence
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Purchasing Managers' Index™ (PMI®) data are compiled by S&P Global for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies, and are available only via subscription. The PMI dataset features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as GDP, inflation, exports, capacity utilization, employment and inventories. The PMI data are used by financial and corporate professionals to better understand where economies and markets are headed, and to uncover opportunities.
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