Euroland: A Jolly Good Friday

• Today we saw a batch of interesting data from Euroland - namely Flash PMIs, German Ifo and industrial new orders. The data were generally strong both on headline and detail and confirm that the recovery is on track with France pulling ahead.
• The PMI new orders index is currently indicating GDP growth at just below 2% q/q annualised. This is very much in line with our expectation of growth at 1.9% q/q annualised in Q3. Given the strong industrial orders data (2% m/m in August) we would not be surprised to see even higher growth in Q4.
• The PMI employment index is currently indicating unemployment growth of about 0.1 percentage point per month. Several indicators (including composite PMI) are signalling labour market stabilisation in early-2010, which is an important precondition for private consumption to recover and the rebound to become more sustainable.
• The current level of new orders is consistent with the ECB being on hold. If new orders hits 55.5 this will be a strong signal that the ECB should soon deliver a 25bp hike. The strong euro could delay the ECB hiking cycle while higher oil and food prices are pulling in the other direction.
• We expect to see continued increases in PMI and Ifo in the coming months, although the speed may soon begin to taper off. The OECD leading indicator signals that all confidence indicators can continue to rise strongly. We also expect that new orders will continue to increase strongly and that we will see strong production data.

Details

Euroland composite PMI increased to 53.0 in October from 51.1 in September (we expected 51.8, consensus 51.6) thus beating expectations. Manufacturing PMI increased to 50.7 from 49.3 (we expected 50.2 and consensus 50.1) and service PMI increased from 50.9 to 52.3 (we expected 51.3, consensus 51.4).

The French data were particularly upbeat with composite PMI increasing from 54.8 to 58.4 and according to the PMI data French recovery is now getting well ahead of German recovery where composite PMI only increased from 52.4 to 52.6. The picture of France moving ahead of Germany is driven in particular by the service sector (French service PMI increased from 53.2 to 57.8 while German service PMI declined from 52.1 to 50.9). The picture is more balanced in the manufacturing sector where French manufacturing PMI increased from 53.0 to 55.3 and German manufacturing PMI increased from 49.6 to 51.1).

Looking at the subcomponents composite new orders increased from 51.3 to 52.5. Manufacturing new export orders increased from 50.1 to 51.5 and it increased in both the German and French data. It is an important signal that this important driver of the first phase of the European rebound remains on track. At the same time the stocks of finished goods declined again and the new order-inventory balance increased to a new record high.

The new order-inventory balance clearly signals that the inventory cycle will add strongly to growth in the coming quarters.

The employment index increased from 44.6 to 45.1. The employment indices for Germany and France also signals that the labour market situation is improving (unemployment is still expected to increase, but at a rapidly declining pace). The Euroland employment index is improving for service, manufacturing and construction. Ifo beats expectations

German Ifo expectations increased from 95.7 to 96.8, thus beating consensus expectations of 96.2 and pretty much in line with our expectations of 96.6. The less interesting current conditions increased from 87.1 to 87.3 - somewhat below consensus expectations. The Ifo institute notices that companies still have plans to cut jobs, but the trend is easing.

Sentiment is improving in both wholesale, manufacturing and construction while retail sees a setback following a jump in September. The manufacturing sector's expectations with regard to production activity in three months have declined slightly while export expectations have increased further. The data still signal that the export-driven German economy is heading for better times.

Ifo expectations currently signal that German industrial production growth rates should increase sharply from minus 17.2 % y/y in August to around 1.5 % y/y.

Strong industrial orders

Euroland industrial orders increased 2% m/m in August - we had expected 1.3% and consensus 1.2%. At the same time the July numbers where revised up from 2.6% m/m to 3% m/m. If we exclude heavy transport equipment we have now had three months in a row with industrial orders rising around 2.5% per month.

The rebound is driven by intermediate goods (3.8% m/m) while both durable and nondurable consumer goods declined (down 1.6% m/m and 2.5% m/m respectively). Capital goods fell slightly (down 0.3% m/m) following two months of strong gains. Industrial orders increased strongly in France (by 3%) and fairly in Germany (1.8%) while Italy saw a 6.4% decline following a couple of months of strong gains. Spain saw another decline (of 0.2%) and is thus not seeing an industrial rebound as yet.

Assessment and expectations

Today's data confirms that the recovery is on track with France pulling ahead. The PMI new orders index is currently signalling growth at just below 2% q/q annualised. This is very much in line with our expectation of growth at 1.9% q/q annualised in Q3. We would not be surprised to see even higher growth in Q4 even though car manufacturing will pull this quarter downward, as the German scrapping scheme has come to an end. The data are in line with a recovery driven by the inventory cycle and exports while private consumption is still not kicking in.

As we move into 2010 sustained growth will increasingly depend on consumers coming back. The order data shows that this is not happening yet, but the PMI and Ifo data gives plenty of hope for a sustained recovery. The improving outlook for the labour market is particularly comforting in this respect. The PMI employment index is currently signalling unemployment growth around 0.1 percentage points per month and several indicators including the composite PMI index are signalling an imminent labour market stabilisation. Historical evidence hints at a stabilisation in early-2010.

The current level of new orders is consistent with the ECB being on hold. If new orders hits 55.5 this will be a strong signal that the ECB should soon deliver a 25 basis points hike. In late-2005 the ECB even delivered a first hike when new orders had just hit 53.9 - although it did move to 55.6 the month after.

The strong euro might slow the Euroland recovery somewhat in 2010 and it might also delay the ECB hiking cycle. Further increases in oil and food prices are also bad for the recovery story, but could nevertheless move forward the first ECB hike as the Governing Council would then begin to be concerned about upside risks to headline inflation.

We anticipate that the confidence indicators will show further gains in the coming months, but the pace of improvement begins to taper off. While our Ifo model signals that we could see a temporary setback the OECD leading indicator signals that confidence indicators can continue to rise strongly in the coming months. We also expect that industrial orders will continue to increase strongly in the coming months and that we will also see strong production data.

Danske Bank
http://www.danskebank.com/danskeresearch

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