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The eurozone economy looks set to contract in the third quarter
as business activity slipped into decline in July and
forward-looking indicators hint at worse to come in the months
ahead. Output and new orders both fell for the first times since
the COVID-19 lockdowns of early 2021. An accelerating downturn in
manufacturing was accompanied by a near-stalling of service sector
growth as the rising cost of living continued to erode the tailwind
of pent-up demand from the pandemic.
Concerns over the weakening of demand were exacerbated by
energy, supply and inflation worries to push business expectations
lower, and also cause a steep drop in input buying and a pull-back
in hiring.
Price pressures meanwhile remained elevated at levels not seen
prior to the pandemic, though rates of inflation of both selling
prices and input costs moderated amid an easing of supply
constraints and weakened demand.
The PMI data showing a renewed contraction and elevated price
pressures therefore underscore the challenge facing policymakers of
taming inflation while avoiding a hard landing for the economy.
Output falls for first time since
early-2021
The seasonally adjusted S&P Global Eurozone PMI® Composite
Output Index fell from 52.0 in June to 49.4 in July, according to
the 'flash' reading. By dropping below the neutral 50.0 level, the
July PMI signals a contraction of business output for the first
time since February 2021.
Excluding pandemic lockdown months, July's contraction is the
first signalled by the PMI since June 2013, indicative of the
economy contracting at a 0.1% quarterly rate.
Manufacturing output fell especially sharply, dropping for a
second successive month with the rate of decline accelerating to
the fastest since May 2020. Barring COVID-19 lockdown periods, the
July drop in factory output has not been exceeded since December
2012. Steepening factory downturns were recorded in both Germany
and France while the rest of the region slipped into decline for
the first time for just over two years.
Service sector output continued to rise, but the rate of
expansion has slowed sharply over the past three months to the
weakest since April 2021. The service sector slowdown indicates
that the boost to demand from the reopening of the economy has
faded and growth is now at a near-standstill, with customers
reportedly often deterred by the increased cost of living and
concerns about the outlook.
However, perhaps of greatest concern is the plight of
manufacturing, where producers are reporting that weaker than
expected sales have led to an unprecedented rise in unsold stock.
Production will likely need to be reduced as companies adapt to
this weaker demand environment, in turn widely linked to rising
prices.
We can highlight three other PMI series which signal worse is
yet to come in terms of the output trend.
First, new orders for goods and services meanwhile fell solidly,
dropping for the first time since February 2021. Excluding COVID-19
lockdown periods, the latest fall in new orders is the steepest
since May 2013.
Second, backlogs of work fell across both manufacturing and
services, declining for the first time in almost one-and-a-half
years, reflecting the recent weakening of demand from customers and
hinting at the build-up of excess capacity.
Third, business expectations for the year ahead fell to the
lowest since May 2020, dropping to a level rarely exceeded in the
past decade. Manufacturing expectations worsened to such an extent
that more firms expect to cut output than increase production in
the coming year, a situation not seen since the early days of the
pandemic (and prior to that, 2012). Future expectations remained
positive in the service sector, though nevertheless fell to the
lowest since October 2020.
Price pressures cool
Although factory output was again constrained in many cases by
component shortages, the overall incidence of supply delays
continued to moderate. Average suppliers' delivery times lengthened
in July to the least extent since October 2020. This easing of
supply chain pressure largely reflected the biggest monthly drop in
purchasing of inputs by manufacturers since the initial pandemic
lockdowns of early-2020.
This steep reduction in input buying by factories in turn
reflected a large rise in warehouse inventories of inputs and the
largest build-up of unsold finished goods ever recorded by the
survey, often linked to lower than anticipated sales to customers
and weakened order books.
The combination of falling demand and easing supply constraints
helped to cool industrial input price inflation. Manufacturing
input cost inflation slowed sharply as a result, down to the lowest
for nearly one-and-a-half years, reflecting lower prices for many
commodities, notably including oil.
Average charges for goods and services meanwhile continued to
rise sharply in July, though the rate of inflation cooled for a
third month in a row from April's all-time high to reach the lowest
since February. Rates of selling price inflation eased in both
manufacturing and services, often reflecting weaker cost growth and
greater price competition amid lackluster demand.
While the overall rate of increase remained significantly higher
than anything seen prior to the pandemic over the two decade series
history, the PMI data point to a peaking of core inflationary
pressures, albeit with energy prices (notably gas) remaining a
major unknown variable in terms of the future path of
inflation.
Policy tightening
The flash PMI data come one day after the ECB raised its main
policy rate for the first time in over a decade, a 50-basis point
hike taking its deposit rate out of negative territory for the
first time in eight years. However, the PMI data highlight how the
ECB is raising interest rates at a time when the demand environment
is one that would normally see policy being loosened, suggesting
that higher borrowing costs will inevitably add to recession
risks.
Chris Williamson, Chief Business Economist, S&P
Global Market Intelligence
Purchasing Managers' Index™ (PMI™) data are compiled by IHS Markit 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.
