Last week saw a big drop in the purchasing managers’ indices for Europe, the US and UK. For Europe and the UK, the composite index fell below 50, which signals contraction. This has revived fears of recession. These PMIs are closely watched, widely regarded as accurate, timely, indictors of overall economic activity. In this week’s Market Perspectives, we take a broader look at the data and conclude that recession risks are high in Europe, especially in Germany, the Netherlands and Italy but that the UK should escape with merely weak growth and the US looks to be on an even firmer footing.
Let’s begin with continental Europe. The data here have been weak across a broad array of indicators. In particular, confidence for consumers and businesses alike has weakened. This is despite falling inflation and record low levels of unemployment. Several factors are behind this. First, although energy prices have come down, they are still well above levels that prevailed before Russia cut off gas supplies. Businesses in Germany that relied on cheap Russian gas can no longer compete. Even though unemployment is low and falling in Germany, the widely publicised surge in corporate bankruptcies is frightening consumers and businesses alike. Coupled with the rise in interest rates, doom and gloom is widespread.
The lack of confidence means that consumers are reluctant to dig into the pile of savings accumulated during Covid. Consumer spending is not weak everywhere, Spanish retail sales are booming. But that tends to be an exception. With inflation still far above the ECBs 2% target, interest rates look set to rise further and negative growth is a distinct possibility over the winter. Unemployment is likely to rise, though probably not by much.
The PMIs have also been weak in the UK, with the latest data showing a big fall, notably in the service sector which had been resilient. But the broader data have been stronger. In contrast to Europe, consumer confidence in the UK has been picking up and signs are that retail sales will rise in the autumn. Yes, every week that passes will see more mortgages re-set to much higher levels, house prices will continue to fall and unemployment is set to rise further. But mortgage rates have fallen significantly from the highs seen in early July and falling inflation means that real incomes are beginning to rise. The Bank of England may choose to raise rates once more but that should see the peak.
PMIs are closely watched but they have been too pessimistic about economic growth for a while now. In Europe, weak PMIs have been corroborated by the hard data, especially in Germany, the Netherlands and Italy. It all adds up to a worrying picture there. There are risks in the UK too. But if my view that inflation is set to fall further is correct, confidence will improve further and growth, while weak, should stay in positive territory. As for the US, recession seems even less likely. The resumption of student loan repayments may cause a blip but the broader economic fundamentals look good.