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Subdued picture from flash PMI data masks widening growth divergences


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Subdued picture from flash PMI data masks widening growth divergences

Major developed economies — the US, UK, eurozone and Japan — collectively contracted for the third month in a row, according to early Purchasing Managers' Index (PMI) survey data for October from S&P Global.

While only very modest, the decline represents a major faltering of growth momentum since a resurgence of demand earlier in the year.

Disappointingly, new inflows of work continued to fall. Until inflows of work return to growth, output is likely to remain under pressure, especially as companies are depleting their reserves of backlogged customer orders. More encouragingly, the inflation outlook improved, with input cost inflation across the four major developed economies falling below its pre-pandemic five-year average in October. This bodes well for consumer price inflation to cool further in the months ahead.

The loss of growth momentum and cooling of price pressures hint at interest rates having peaked in the US and Europe, which has helped lift business confidence. Expectations of output turned higher in October across the four major developed economies. This came amid rising geopolitical tensions and hopes that demand will strengthen again as households and businesses see cost-of-living pressures lifting and peak interest rates in sight.

However, these future output expectations have diverged, signaling a further outperformance of the US relative to Europe.

Major developed economies contract at start of Q4 2023

Business activity across the four largest developed world economies — also known as the G4 — fell for a third successive month in October, according to the provisional flash PMI data compiled by Market Intelligence. This suggests a soft start to the fourth quarter for the developed world economy.

The decline in October was only slightly more marked than witnessed in September. Still, it represented a significant contrast to the robust growth signaled during the second quarter, hinting at a considerable downshifting in global economic growth momentum.

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Near-term prospects remain uncertain, as backlogs of work continued to decline in October. Falling backlogs were recorded in both manufacturing and services, matched by deteriorating output conditions, with manufacturers suffering marked declines while services activity stagnated.

This depletion of outstanding business reflected the fact that new order inflows across the G4 once again fell at a faster rate than output. Companies had to rely on the previously placed orders to sustain current levels of capacity utilization. Unless new order inflows start to lift higher, risks to output in the months ahead remain tilted to the downside as these backlogs of work will eventually be depleted.

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Europe leads slowdown as US outperforms

The economic malaise was again led by Europe, with the US notably outperforming as its expansion regained some poise, albeit remaining somewhat lackluster.

Eurozone output contracted for the fifth month in a row in October as the flash PMI fell to 46.5 from 47.2. The rate of decline was the steepest since November 2020. Excluding pandemic months, the fall in activity was the sharpest since March 2013. The current level of the eurozone PMI is broadly consistent with eurozone GDP falling at a quarterly rate of 0.4% at the start of the fourth quarter after the data signaled a 0.3% contraction in the third quarter.

A seventh successive month of falling output in the euro area's manufacturing sector was accompanied by a third month of contracting service sector activity. Factories remained in the deepest downturn since 2009, barring the early pandemic lockdowns.

UK output fell for the third straight month — albeit to a lesser extent than the eurozone — as the PMI edged higher to 48.6 from 48.5. The pace of decline has also remained largely unchanged over the past three months to signal only a very modest recession risk. The UK PMI is broadly indicative of GDP falling at a quarterly rate of just over 0.1%, having pointed to a 0.1% quarter-on-quarter GDP contraction in the third quarter.

Service sector output fell in the UK for a third successive month. Although again only modest, the sustained downturn represents a major change to the buoyancy seen in this part of the economy earlier in the year. The decline was the steepest since January.

UK manufacturing output continued to fall sharply in October, dropping for an eighth successive month with the rate of contraction easing only slightly.

US growth ticked higher, with the flash PMI up to 51.0 from 50.2 in the prior two months. Growth is very modest still and suggests weak momentum going into the fourth quarter. The US flash PMI is consistent with annual GDP growth of approximately 1.5%, hinting at a lower underlying growth profile than official GDP data are expected to show for the third quarter.

In contrast to Europe, the US saw growth in both manufacturing output and services activity in October, although rates of growth remained lackluster even as they improved from September. Much like Europe, the US has seen a marked cooling of its service sector expansion since earlier in the year.

Meanwhile, Japan lost its recent shine. The flash October PMI slipped to 49.9 from 52.1 to signal the first contraction since December 2022. The Japan flash PMI points to GDP growing at an annual rate of just under 1.0% at the start of the fourth quarter, which is in line with the pre-pandemic 10-year average.

Factory output fell in Japan at the quickest rate since February as destocking exacerbated weaker demand growth. Services activity remained in expansion amid still-robust consumer services demand. Anecdotal evidence highlighted that tourism demand continued to support service sector growth, but the expansion slowed sharply.

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Demand downturn brings lower price pressures

Price pressures cooled further in October, offering one upside to the downturn in demand. Input costs across manufacturing and services rose in the G4 at the slowest rate since November 2020.

Lower wage growth — employment growth in the G4 over the past three months has been the lowest since early 2021 — and falling goods prices have helped offset higher oil prices. The impact of the latter, and how central banks deal with this, will be a key aspect to monitor in the coming months.

The combination of falling output, weak demand and slower cost growth means there is good reason to believe developed world interest rates have peaked.

The need for rates to remain high for long will be tested by the PMI data in the coming months. Further falls in service sector inflation, in particular, will be eagerly sought in support of any conviction that rates have peaked.

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Diverging outlooks for US, Europe

The improving inflation outlook, as well as signs of interest rates peaking, played a role in lifting business confidence in October. Expectations of output in the year ahead across the G4 rose to the highest since June, even though the gain was limited to the US.

The forward-looking data add further to the likelihood of the US outperforming Europe in the months ahead, with a soft landing for the former contrasting with rising recession risks in the latter.

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Purchasing Managers' Index data is compiled by S&P Global for more than 40 economies worldwide. The monthly data is derived from surveys of senior executives at private sector companies and is 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 is used by financial and corporate professionals to better understand where economies and markets are headed and to uncover opportunities.

Full PMI data are available only via subscription. For more information or to express your interest, please contact your S&P Global relationship manager.

Data and insights for this article were compiled by Chris Williamson, chief business economist for S&P Global Market Intelligence.

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