European Manufacturing PMIs Fall Again - The ECB Needs To Do Something

by: Tim Worstall

Manufacturing is the most variable sector of the economy - a canary in that coal mine.

The PMIs for various European economies are falling, indicating at very best softening economic conditions.

The ECB should be doing something - but what is it they can do?

The European Economies

It's not really valid to talk of a European economy, that being exactly the problem there is with the euro. Having the one currency means that monetary conditions must be the same across those different European economies. An example of this is that the UK economy seems to be slowing at the same time as many others - but monetary policy there is independent and can thus react.

Given this problem, we still do seem to have a general slowdown in manufacturing going on across the continent. This won't be all that much to do with trade wars simply because Europe isn't really taking part in them. It's China and the US having the spat. But slowing economies do mean there should be a change in policy. But what is there that the European Central Bank can do?

Germany Manufacturing PMI

As we saw from our preliminary reading earlier, we are seeing weakness in German manufacturing output:

Flash Germany Manufacturing PMI(3) at 43.1

(Jun: 45.0). 84-month low.

Just to reiterate what a PMI is. We can read what GDP is, actual economic output, going backwards. But it's a trailing indicator, of course, it's something that has happened that we then count. What we want is something to tell us what is going to happen - a leading indicator. Everything that gets made has to be made of stuff, so, why not go ask the people who buy the stuff what that stuff is made of? Go ask purchasing managers what they're buying now for future production.

Set that as an index, 50 meaning everything is static. More than 50, production is at least planned to expand, less than contract. And historically, these PMIs have done a good job of predicting future changes in GDP.

We're not happy therefore with a PMI significantly below 50. And especially not for Germany where manufacturing is about twice as a portion of the economy as it is elsewhere. Roughly, you understand, manufacturing is about 10 to 12% of rich world economies these days. The US, UK, France, etc., all about the same. Germany and Switzerland are different, up at more like 25% of all economic activity is manufacturing.

Manufacturing matters a lot more in Germany than it does elsewhere. So, we have our actual PMI numbers for manufacturing in Germany and they're not looking happy:

The headline IHS Markit/BME Germany Manufacturing PMI – a single-figure snapshot of the performance of the manufacturing economy derived from indicators for new orders, output, employment, suppliers' delivery times and stocks of purchases – sank deeper into contraction territory in July. At 43.2, down from 45.0 in June, the latest reading signalled the steepest decline in overall manufacturing conditions since mid-2012.

In graphic form:

Germany manufacturing PMI (Germany manufacturing PMI from IHS Markit)

We'd really hope for some change in monetary policy to overcome this.

Eurozone PMI

Much the same is true for the eurozone as a whole:

Final Eurozone Manufacturing PMI at 46.5 in July (Flash: 46.4, June Final: 47.6).

Output and orders both down markedly as confidence hits lowest since December 2012.

Sharpest recorded reduction in employment for over six years.

Part of this, of course, is simply due to the size of Germany's economy - especially the manufacturing part of it - relative to other eurozone economies.

The ECB is the monetary authority for the whole of the eurozone, of course, that's rather the point.

A Problem, The French PMI

The thing is, conditions aren't the same across the eurozone. The French PMI is markedly better:

The seasonally adjusted IHS Markit France Manufacturing Purchasing Managers' Index (PMI) – a single figure measure of developments in overall business conditions – fell to 49.7 in July, down from 51.9 in June. The reading signalled a slight deterioration in operating conditions faced by manufacturers in France, following improvements in both May and June.

Given the levels of accuracy here, that's about flat, rather than the significant fall we're seeing elsewhere. So, the ECB is trying to fit a single monetary policy around different economic situations.

Actually, It Gets Worse

We have a range of PMIs from across the eurozone:

Eurozone PMIs (Eurozone PMIs from IHS Markit)

All of which pose something of a problem. It's clearly not true that Greece needs looser monetary conditions. Not obvious that the Netherlands or France do. Germany certainly does. So, what's the ECB supposed to do when its only tools apply in all places?

Sure, This Is A General Problem

This is a general problem for the eurozone itself. The very fact that it's a single currency means it's a single interest rate area. And that's why I've always been against it - it's too large to be an optimal currency area.

But leaving politics aside, there's an economic problem here. Just what is it that the ECB can do? Not, actually, a lot.

My View

I insist that Germany needs lower interest rates, looser monetary conditions, given that manufacturing PMI. And it's clear and obvious that the ECB can't loosen policy enough for Germany given the conditions in those other countries. Fiscal policy in Germany isn't going to be loosened enough to take care of it either. I think we're in for a German recession.

The Investor Takeaway

Of course, there are still investment attractions in Germany, there always are everywhere. But the macroeconomic numbers are such that investments based upon the general state of the local economy aren't going to do well. Significant growth stocks playing in the global sandpit will do as they always do, according to their own specifics. But companies working primarily in mature industries in the German domestic economy won't.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.