Weekly Economic Briefing

Standard Life’s Global Outlook Report.

With all the negative headlines coming out of the Ukraine and Middle East in recent weeks, it has been easy to forget that the global economy is actually in fairly good shape.

Helped by generally loose financial conditions, as well as pent-up demand in most developed economies after years of tepid growth, the global composite Purchasing Managers Index (PMI) held up at 55.1 in August.

That reading is a little lower than the levels recorded in June and July, but it is still the third highest outturn since the beginning of 2011. Helpfully, the global recovery is becoming less dependent on manufacturing activity to drive growth.

Whereas the global manufacturing PMI is currently at 52.6, signalling healthy though not spectacular growth, the global services PMI is sitting at 55.5, not far from a post-financial-crisis high. Taken at face value, such levels of business sentiment are consistent with above trend global output growth, although there has been a tendency for the PMIs to overstate official GDP growth in recent quarters.

While the global backdrop is undoubtedly positive, not all countries and regions are sharing in the wealth equally (see chart 1).

Among the world’s largest economies, the US and UK continue to lead the way, reinforcing our view that the Federal Reserve and Bank of England will be the first central banks to begin raising short-term interest rates.

The US in particular appears to be accelerating into the second half of the year, led by vehicle sales and business investment. Sentiment is also holding up fairly well in Japan, although it is well below the levels recorded at the beginning of the Abe revolution and the rebound from the sales tax hike has been weaker than hoped.

However, the biggest disappointment is the Euro-zone, where the recovery is in danger of petering out before it even began. The biggest drags are still France and Italy, although even German growth has moderated of late; no prizes then for guessing why the ECB announced new easing measures last week.

The BRICs remain a mixed bag. The Chinese authorities are pushing to hit their 7.5% growth target, despite the related financial risks being generated.

Meanwhile, Russia is sinking under the weight of sanctions and Brazil has fallen into recession. Indeed, only the Indian economy seems likely to accelerate in the second half of the year.

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• The Performance of Manufacturing index fell by 4.4 points in September to a nine-month low of 47.3.  Any
  reading below 50 means the manufacturing sector is contracting.
• Of more concern, the production sub-index fell to a nine-month low, employment is now at 11 month lows and new orders have slumped to 14 month lows. Eight of the 12 sectors weakened in September.

What does it all mean?

• The decline in the latest manufacturing gauge highlights just how patchy the Australian economy is at present. Not only is manufacturing activity once again contracting, but the key sub indices such as new orders, employment and production have turned sharply lower – a worrisome trend that does not bode well for coming months. Even selling prices are still falling, while input costs and wages rising – pointing to pressure on profits.
• As we have highlighted over the past couple of weeks, there are clear signs that the economy has lost momentum and looking forward activity is likely to be less robust – especially given that the recent strength of the Australian dollar will continue to make Aussie exports less competitive. The strong Aussie is likely to depress not just the manufacturing sector but tourism, and agricultural exports.
• Fundamentally the economy is still in good shape but near term rate hikes are likely to curb the activity and growth at a time when inflation is still well contained.

What do the figures show?

Performance of Manufacturing index

• The Performance of Manufacturing index hit a nine-month low in September, falling by 4.4 points to 47.3. A reading below 50 suggests that the manufacturing sector is contracting.
• Key activity components of the PMI were sharply lower in September. Production, new orders, employment and exports fell sharply. The production sub index dropped 5.3 points to 46.2. And new orders fell by 4.1 points to 46.5. And the employment index lost 6.5 points to 44.8. And exports fell by 1.9 points to 51.2. The index of selling
  prices eased modestly to 47.4 while input prices and wages recorded a slight increase.
• In seasonally adjusted terms eight of the 12 sectors recorded a decline in activity in September.

What is the importance of the economic data?

• The monthly Performance of Manufacturing Index is the Australian equivalent of the US ISM manufacturing gauge.  The PMI is one of the timeliest economic indicators released in Australia. The PMI is useful not just in showing how the manufacturing sector is performing but in providing some sense about where it is heading. The key ‘forward looking’ components are orders and employment.

What are the implications for interest rates and investors?

• The softening in manufacturing conditions would be negative for material suppliers and resources companies and could end up having knock-on effects for other businesses.

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