ECONOMICS COMMENTARY — Jul 25, 2023
Flash PMI signal further cooling of developed world economic growth in July
Economic growth trends generally worsened at the start of the third quarter, according to the flash PMI surveys. US business activity growth slipped to a five-month low, the UK slowed to near-stagnation and the Eurozone fell into a steeper decline. Growth in Japan meanwhile held stuck June's four-month low. In all cases, encouragingly robust growth rates seen earlier in the year are showing signs of faltering as a persistent manufacturing malaise is accompanied by waning demand for services.
The flash survey price gauges are meanwhile sending mixed signals, with cooler inflation signaled in Europe but with signs of stickiness in the US around the 3% mark.
The extent to which inflation can close the gap from 3% closer to central bank 2% targets will be determined to a degree by labour markets. Resilient jobs growth and labour shortages have kept wage growth elevated in recent months. However, the latest PMI data point to a cooling in demand for staff, which looks set to intensify given a recent deterioration in order books and a sharp decline in business confidence across the G4 economies.
Economic growth in the major developed economies slides to lowest since February
Business activity across the four largest developed world economies (the "G4") slowed for a second straight month in July, down to its weakest since February, according to the provisional 'flash' PMI data compiled by S&P Global. Although output rose for a sixth successive month in July, the overall expansion was only very modest to hint at a near-stalling of growth and potential downturn in the coming months if the current weakening trajectory persists.
Manufacturing output in the G4 economies contracted for a third consecutive month, and for the thirteenth time in the past 14 months. The rate of factory output decline remained among the sharpest seen since the global financial crisis, albeit easing slightly on June. New orders for goods likewise fell sharply, notably continuing to deteriorate at a steeper rate than output to hint at further production weakness in the coming months as producers face increasingly depleted order books.
The service sector meanwhile continued to lose growth momentum, expanding across the G4 in July at its slowest rate since February. New orders growth slowed especially sharply, pointing to a marked cooling of the resurgence of service sector demand seen earlier in the year.
Europe leads slowdown
Europe saw the steepest deterioration in performance, though growth also slowed in the US and remained subdued in Japan.
The eurozone saw output fall for a second month, the contraction gathering pace on the marginal decline recorded in June to register the steepest downturn since last November. The PMI nonetheless signaled a decline commensurate with GDP falling at only a modest 0.1% quarterly rate in July. However, the region saw a steepening loss of new orders and a steep decline in business optimism, boding ill for output growth in the months ahead. Eurozone manufacturing output fell especially sharply and service sector growth came close to stalling amid a renewed decline in new orders.
Business output growth meanwhile came close to stalling in the United Kingdom, registering the smallest gain since the current upturn began in February. The latest composite flash PMI reading is consistent with flat GDP. An increasingly severe manufacturing downturn was accompanied by a near-faltering of service sector growth to a six-month low.
Growth remained more resilient in the United States, though nonetheless weakened sharply to the slowest for five months. The latest flash composite PMI reading is indicative of US GDP growing at a quarterly rate of just under 0.4% (1.5% annualized) in July, down from around 0.5% (2% annualized) in the second quarter. A largely becalmed manufacturing economy was accompanied by a downshifting of service sector growth to the weakest since February.
Japan was the only G4 economy not to see its output trend worsen, though the rate of expansion merely held at a pace comparable to June's four-month low, down sharply from May. Manufacturing remained in decline and the service sector continued to lose growth momentum.
Increasingly broad-based deterioration
The July data therefore point to a continuation of the two broad themes that we identified in June, which are generating an increasingly broad-based deterioration in the pace of growth.
First, manufacturing continues to be hit by a post-pandemic shift in spend, notably from households, away from goods to services. This has been exacerbated by destocking, as companies unwind high inventory levels which had been built up in prior months in response to supply shortage worries. A further factor has been the sluggish economic rebound in mainland China so far this year, which has subdued demand for many goods, especially capital equipment.
Factories across the G4 as a whole are hence reporting that their backlogs of work, which had accumulated in the pandemic, have been depleted in recent months at a rate not seen since the global financial crisis, barring only the initial COVID-19 months, amid a dearth of new order inflows.
Second, the resurgence of growth in the service sectors of the G4 economies appears to be losing steam. While pent-up savings and pent-up post-pandemic demand for holidays and leisure had spurred strong service sector expansions in the spring, these upturns are showing signs of cooling, likely linked to the lagged impact of higher interest rates. The increased cost of living also continued to be widely cited by companies as a dampener on demand.
We will know more about these trends with the release of detailed sector data on 4th August. However, with interest rates widely expected to rise again in the US, Eurozone, UK - and the lagged impact of prior rates set to fully feed through to businesses and households - there are clearly further downside risks to the growth outlook.
Mixed news on inflation
While one further rate hike by the FOMC, ECB and Bank of England seem certainties given recent central bank rhetoric, the prospect of further rate hikes has become increasingly uncertain, given the recent PMI developments. However, although the flash PMIs signal a broad-based cooling of growth momentum and, in the case of Europe rising recession risk, news was mixed on price pressures.
In the Eurozone, average selling prices for goods and services rose at the slowest rate for just under two and a half years, led by the steepest drop in manufacturing prices since 2009 (barring the pandemic). However, eurozone service sector selling price inflation also slowed, down to its lowest since October 2021.
UK selling price inflation meanwhile also sank to its lowest for nearly two-and-a-half years, with falling goods prices accompanied by a slowing in service sector inflation to the weakest since August 2021.
Although both in the Eurozone and UK services inflation remained elevated by historical standards, the survey data point to a further cooling of consumer price inflation in the months ahead to around the 3% mark.
Of greater concern were upticks in selling price inflation in the US and Japan, linked in part to higher oil prices as well as upward pressures from wage growth. While the US survey data brought further encouragement in the form of largely unchanged goods prices, the persistence of stubborn service sector inflation points to consumer price inflation remaining sticky at around the 3% mark in the coming months.
Labour markets to hold clues to rate paths
With the stickiness of inflation in the service sector largely linked to wages, the resilience of the labour markets in the major developed economies will likely hold important clues as to the future paths of inflation and central bank policy rates. However, July saw some cooling of the jobs markets.
Across the G4 economies as a whole, employment rose in July at the slowest rate since January, according to the flash PMIs. The overall rise was only modest, reflecting slower rates of net job creation in all four economies. Jobs growth came close to stagnating in Japan, sank to a 29-month low in the Eurozone, a six-month low in the US, and the joint-lowest for four months in the UK.
Moreover, in all four economies, falling levels of backlogs of work hint at further pressure on companies to reduce headcounts in the coming months, absent a revival of demand growth.
However, such a demand revival is not widely expected: companies' business expectations fell sharply across the G4 in July to the lowest so far this year, suggesting the focus will increasingly shift towards belt-tightening rather than business expansion.
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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