Facts:
The composite PMI fell by 2.4pts (to 55.4) reflecting a 3.2pt drop in the manufacturing PMI (to 54.8) and a 1.3pt drop in services activity (to 55.4). The current composite PMI readings point to a softer Q2 than the 0.8% q-o-q rise in Q1 GDP (chart 1), but a growth rate that is still above trend. Nonetheless the scale of the drop in May was noteworthy. All of the individual components of the composite survey fell and the forward-looking components such as the new orders/stock outstanding ratio (chart 2) point to a further slowing. Employment was relatively resilient, edging down only slightly from 53.1 to 52.7 on the composite series.
The manufacturing survey fell more than services with the former falling from 58 to 54.8 and the latter from 56.7 to 55.4. Details are only available for Germany and France, where the overall levels of the composite PMIs remain above that of the Eurozone but the scale of the slowdown in Germany is becoming much more marked. It continues to outperform on the manufacturing side but is now below the Eurozone aggregate in the services sector (charts 3 and 4). The press release from Markit stated that service sector activity in the periphery was particularly weak, with output falling for the first time in four months. While the latter is no doubt largely explained by the austerity measures, the real income squeeze from the commodity price shock is also taking its toll in the periphery and elsewhere.
On a positive note, the fall back in commodity prices has been reflected in a marked slowing of the prices components in the manufacturing and services sector, particularly on the input side which fell from 78.9 to 69.3 in manufacturing. Hence the gap between input and output prices is now narrowing (chart 5) but we still expect some upward pressure on output prices to persist in the coming months, not least in utility prices.
Implications:
Given that the PMIs were at or close to record highs, some degree of slowdown was inevitable. The May reading could be overstating the deceleration, which may be partly explained by the late timing of Easter and the Japan-related disruptions, but we find it hard to identify any Japan effect in the PMI data. In Germany the supplier delivery times component, which had fallen to 31 in April (indicating longer delivery times), actually rose significantly in May to 37.
We remain of the view that growth in the Eurozone will soften in Q2 and then more markedly in the second half of this year, as a result of the lagged effect of the squeeze on real incomes from the commodity price shock and a less supportive external demand environment (as indicated by the relatively soft flash estimate for then China PMI released this morning). However, with growth in the Eurozone still above trend in Q2 and headline inflation stuck at around 2.8% for much of the rest of this year, we still expect the ECB to signal a July interest rate rise at its next meeting on June 9.
Bottom Line:
A sharper than expected slowdown in May, but growth is still above trend and we still expect the ECB to continue its slow normalisation with the next +25bps move to 1.5% forecast for July.
Chart1
Chart2
Chart3
Chart4
Chart5
HSBC Global Research