Leading Indicators Dipping but Expansion Continues

Leading Indicators Dipping but Expansion Continues

The latest Purchasing Managers Index (PMI) report from IHS Markit demonstrates that aggregate private sector business activity has rebounded in the UK, Europe and the US.

The latest PMI release, known as a ‘flash’ report, encompasses 85-90% of the full sample. The flash report is an example of a high-frequency data point used by policymakers for fine-tuning their actions.

UK PMI:

The UK Composite PMI Index encompasses data from the manufacturing and service sectors and is now in its third consecutive month of expansion (a reading above 50.0 represents month on month expansion, while a reading below represents contraction). However, the flash update reveals a downward blip.

To identify what is happening, we need to look beyond the headline number and inspect the individual components of the composite index. In other words, we need to focus on the service sector, which includes industries such as hospitality, tourism and consultancy, and the manufacturing sector, which provides for industries turning raw materials into tangible goods such as car manufacturers.

Chart 1.0: UK IHS Composite Index

Source: Bloomberg, September 2020

The dip in the composite measure from 59.1 to 55.7 between August and September is due to a downward move in the services component. In August, incentives to support services such as hospitality with the popular ‘Eat out to help out’ scheme boosted spending, but these have now rolled off. Housing activity is being helped by cuts to stamp duty, with the cut likely to remain in place for some time. However, a further retightening of restrictions will now weigh further on service sector demand expectations.

On the manufacturing side, UK based firms were quick to increase production levels to meet demand. The production increase is helping slow the pace of job reductions as we move out of furlough measures and into the Chancellors new Jobs Support Scheme.

Eurozone PMI:

European PMI reports paint a similar picture. Manufacturing output growth rallied at the fastest rate since February 2018 with the Manufacturing PMI coming in at 53.7 (up from 51.7 in August). Increased activity in the Euro bloc was supported by their biggest manufacturing economy, Germany, who reported their largest hike in new work orders in more than a decade.

However, the service sector in Europe also recorded a pull-back as Governments across the Eurozone have imposed localised restrictions. Firms offering face to face services in hospitality and tourism are bearing the brunt of the reduced activity, impacting their ability to bring employees back to work.

Chart 2.0: Eurozone IHS Composite Index

Source: Bloomberg, September 2020

US PMI:

In in the US resilience in the manufacturing sector is also evident with demand improving; a reading of 53.5 v 53.1 in August. The service sector, which makes up 70% of the US economy, also produced an expansive PMI of 54.6, driven by increased domestic demand as client operations resume benefitting the overall composite index which held above 50.0 as demonstrated below. But managers in the US survey are now more cautious on their outlook given the looming Presidential Election on November 3rd, and growing demand for an additional fiscal support package from the government. Until that point comes, analysts can take comfort in recognising average saving rates in the US remain elevated relative to history, which could provide a form of armoury to tide a number of consumers over until an agreement arrives.

Chart 3.0 US IHS Composite Index

Source: Bloomberg, September 2020

So, What Lessons Are We Learning?

  1. Three major economic areas are expanding, but expanding unevenly across different sectors.
  2. The service sectors remain highly susceptible to any tightening of rules related to containing the spread of this nasty virus.
  3. An easing of the rate of growth month on month is not a surprise because PMI’s have been recovering coming from a shallow base effect evident in the second quarter of this year.

In our view, it is essential to be aware that paths to recovery are bound to be uneven. Economies are waxing and waning in response to stimulus measures and responding to the extent to which restrictions are tightened and relaxed.

The UK and Europe are in the early stages of gaining additional government support. The authorities, recognising the potential for additional damage as we approach the winter months are once again stepping up. However, in the US wrangling over how much to spend and where to spend support monies may continue until after the US election.

The UK Chancellor’s Winter Economy Plan

The widely anticipated Autumn Statement has been deferred as we once again confront restrictions which will knock on into spending intentions and jobs. The new plan contains several measures supportive of consumers, businesses and jobs including:

  • Furlough to be replaced with the Job Support Scheme on November 1st to protect jobs (Jobs Retention Bonus will remain in place).
  • Extension of the Self Employment Income Support Scheme Grant.
  • VAT rates are to be frozen at the reduced rate of 5% (from 20%) for an extended period through to the end of March for the tourism and hospitality sectors
  • Additional breathing space for business who deferred VAT bills via the New Payment Scheme, giving them the option to pay bills across 11 smaller instalments through 2021/22.
  • Greater accessibility for business interruption loans along with an extension on the repayment schedule of bounce back loans – extending the repayment period from 6 years to 10, reducing repayment costs.

Growth Forecasts

Analysts tasked with forecasting outcomes have a difficult job right now. However, we note they have put pen to paper, and below you will find their up to date forecasts. These estimates take account of the current support measures and indicate expansion remains underway despite the challenges raised.

Chart 4.0: Quarterly Economic Growth Rates – Confirmed and Forecast

Region Q1 2020 Q2 2020 Q3 2020 (Estimate) Q4 2020 (Estimate)
UK -2.2% -20.4% +15.5% +3.4%
Eurozone -3.7% -11.8% +8.4% +2.4%
US 0.3% -9.1% -4.4% -3.9%

Source: Bloomberg, September 2020

Conclusions:

  • PMI data presents further evidence of an improvement in business supported by resilience in manufacturing.
  • Survey results understandably present a more cautious outlook for the service sector; especially now with tightening of restrictions in the UK and Europe.
  • The path to recovery will not be linear. Supportive policy measures from governments are being deployed as we shift into the winter period.

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