The main survey of the private sector in the euro area leaves bad signs in July. On the one hand, activity continues to deteriorate without parallel in the region, with notable declines in its two large economies: Germany and France. On the other, the evil of inflation continues to make distressing headlines: in the services sector, prices do not let up, to the concern of a European Central Bank (ECB) that has not just found a landing strip to put an end to rate hikes despite the damage that the economy may experience.
The purchasing managers’ indices of private sector companies (PMIs) leave this impression on Monday in their preliminary reading for the month of July. According to data from S&P Global and Hamburg Commercial Bank, responsible for the survey, the Eurozone Composite PMI it has fallen from 49.9 points in June to 48.9 in July, its lowest level since last November. With this decline, the indicator deepens into the contraction zone (readings of less than 50 points, which would imply a scenario of stagnation).
The great ballast is once again the month PMI manufacturing, which on this occasion fell from 43.4 points in June to 42.7, registering the worst reading in 38 months, that is, since the worst of the outbreak of the pandemic in the first half of 2020. On the other side, the services sector, which has been the mainstay of activity in the reopening of the economy after the closures due to the covid, is beginning to show wear. He Services PMI July has been 51.1 points compared to 52 the previous month. Although it remains in expansion territory, it marks the lowest reading in six months and continues to move away from the positive readings above 55 points this spring.
The latest reading signals a second consecutive monthly drop in output in volume terms after five months of continued expansion, with the pace of contraction accelerating from the marginal decline recorded at the end of the second quarter. Meanwhile, the conditions of the demand They got worse overall. New business entries have fallen at an increasingly severe pace in July, recording the biggest decline since last November.
The descent of the new orders it has notably outpaced production to a degree not seen since February 2009, suggesting that companies will seek to cut production further in the coming months in response to the worsening demand environment. The increasing loss of new orders in the goods production sector, which experienced one of the steepest declines since 2009, has been accompanied by the first drop in new orders for services in seven months.
The dearth of new orders means that work portfolios have been reduced at an increasing rate, as companies often relied on previously placed orders to maintain current operating levels. Excluding the initial months of the Covid-19 lockdown, the latest drop in the order book was the biggest since February 2013 and, for the manufacturing sector, the steepest since 2009. The service sector order book fell in July for the first time in six months.
The deterioration of the situation of the order book has diminished the business trusttaking the expectations of the companies on the levels of production for the next year to their lowest level since last November.
These bad data in the European whole come from the two main economies of the bloc, Germany and France, which have started the third quarter with contractions in the private sector, with sustained weakness in the manufacturing sector that has spread to services. Germany’s composite PMI has fallen to its lowest level this year, reading 48.3 in July. France has fared even worse, reaching its lowest level in 32 months, 46.6 points.
In Germany, the negative reading has been driven by the manufacturing sector, which has been below 50 for more than a year and is now close to levels last seen at the start of the pandemic. Likewise, the growth of services slows down for the second consecutive month. In France, both the manufacturing and service sectors contracted again, although the former is in the worse shape of the two.
“It increases the probability that the german economy I went into recession in the second half of the year“, has valued Cyrus de la Rubia, chief economist at Hamburg Commercial Bank. “In recent months, we have witnessed a dizzying drop in both new orders and the backlog, which are now declining at their fastest rates since the initial wave of Covid in early 2020. This does not bode well for the rest of the year.” “The data points to a noticeable cooling of the French economyshowing the largest reduction in business activity since November 2020, which preceded a contraction in GDP,” sums up Norman Liebke, also an economist at the German bank.
If on the side of the activity, the headlines are not good, on the side of the prices they are almost worse. Input price pressures have continued to ease, but this was almost entirely due to lower costs in the manufacturing sector, which in turn likely reflects lower energy prices, as well as improving global supply conditions. In contrast, the PMI for input costs in the services sector hardly changed in July, and the Services Producer Prices PMI It has stood at 55.8 points. Although down from the previous 56.3 points, it is still well above its long-term average of 51 points.
“The manufacturing sector continues to be the Achilles heel of the eurozone. Producers have again reduced their production at an accelerated pace in July, while service sector activity continues to expand, albeit at a much slower pace than at the beginning of the year. The eurozone economy is likely to enter contractionary territory in the coming months as the service sector continues to lose steam. Adding to these gloomy prospects is the fact that both the services sector PMI start-ups and pending companies have fallen into contractionary territory for the first time since the start of the year. These trends are especially pronounced in the manufacturing sector, suggesting that the slump here is likely to continue as the second half of 2023 progresses,” De la Rubia summarizes in the report with the data.
“France and Germany look especially gloomy, with production PMIs signaling contraction, which is slightly offset in the rest of the eurozone. We don’t have more details yet, but this could be because the economies more dependent on tourism they benefited from a somewhat stronger summer period. Even so, the positive effect of tourism does not seem strong enough to offset the weakening of the economy elsewhere,” diagnoses Bert Colijn of ING.
“We have argued before that the eurozone economy has been in a stagnant environment, and the last two quarters of minimal negative GDP growth should not be taken as a generalized recession, given the strength of the labor market. However, the July PMI suggests that the risk of recession has increased. With expectations of further weakening in production, the outlook for the coming months is weak at best,” adds the Dutch bank analyst.
Complications for the ECB
“The Eurozone PMIs for July are in line with our non-consensual view that the currency union economy will remain in recession. But they also suggest that the labor market will remain tight, with high wage growth and strong core inflation“says Jack Allen-Reynolds of Capital Economics.
De la Rubia affects the flank of inflation: “The latest reading of the PMI ECB officials will not like it, since prices in the private sector continue to rise, led only by the important service sector. So ECB President Christine Lagarde will stand her ground and raise interest rates by 25 basis points at the next monetary meeting at the end of the week.” In June, service inflation picked up from 5% year-on-year to 5.4%.
“The inflation picture emerging from the survey is very similar to that of recent months. Price pressures are cooling, but more so for manufacturers of goods than for service providers. The increase in wages services price pressures remain elevated, translating into a slower downward trend. The fall in input costs is helping to reduce inflation expectations much faster in the case of goods. This confirms our view of a materially lower inflation rate towards the end of the year, but keeps hawks concerned about the effect of wages on inflation alive,” adds ING’s Colijn.
Face to September, these data could help tip the balance towards more ECB hikes after some hawks have set the stage for a post-summer pause. Christoph Weil, economist at Commerzbank, is not so sure: “Today’s data also speaks against the ECB raising key interest rates further after the quasi-announced rate hike in July. Until now, ECB forecasts were based on the assumption that the euro area economy would continue to grow remarkably in the second half of the year. Today’s Purchasing Managers’ Index figures are likely to lead to a revision of these expectations and a major revision. lower than their September forecasts”.
“With economic weakness spreading, the outcome of the September meeting is increasingly close. Today, the only news hawkish come from service price indicators. But with headline inflation slowing and the labor market weakening, a forward-looking analysis would point to no further tightening after this week. In September, the ECB will not get the ‘sustained turn down’ in core inflation that it wants to see before stopping the rises. But they will see much more weakness in activity than they anticipated in June. So ultimately it all depends on how foresight the ECB wants to be after the summer break. For now, this is very uncertain,” says Tullia Bucco of UniCredit Research.