Euroland: PMI Heading Towards 50

• Euroland flash PMI increased strongly - in particular for manufacturing. We believe that PMI will go above 50, which signals expansion, as early as August.
• The new order-inventory balance, which is now at a record-high level, is signalling sharp increases in PMI in the coming months.
• Today's positive data indicate that we are likely to see a partial manufacturing recovery in Euroland soon. We expect to see positive GDP growth in Q3.
• The employment index improved slightly from a 10-year low. The pace of manufacturing job losses slowed, but it increased in the service sector.

Details

Euroland flash PMI surprised on the upside today as the composite index rose strongly from 41.1 in April to 43.9 in May (consensus 42.3). Manufacturing PMI increased from 36.8 to 40.5 while consensus had expected an increase to 38.4 and we had revised our projection up to 39.5 after we received very promising ZEW expectations.

Manufacturing new orders index continued to increase strongly from 37.7 to 42.0. At the same time, inventories of both finished goods and stocks purchased continued to decline to new record lows. The manufacturing new order-inventory balance has raced to a record high level, and is now signalling a very strong rebound in manufacturing PMI in the coming months.

Services PMI increased from 43.8 to 44.7, which was almost in line with consensus expectations and somewhat below our more upbeat estimate. The improvement in services seems to have lost some strength in May.

Flash PMIs for Germany and France released earlier today showed improvements for both countries albeit the improvements were strongest for Germany. German composite PMI increased from 40.1 to 44.4 while French composite PMI increased from 43.8 to 46.1.

Finally, the composite employment index recovered slightly from a 10-year low reached in April. Still the level is very subdued and signals that unemployment will rise sharply in Euroland this year. The manufacturing employment index actually improved quite sharply in May, but the service sector employment index deteriorated further. The construction sector employment index also improved slightly. The employment index tends to be a lagging indicator.

Assessment & Outlook

Today's data indicate that we will soon see a manufacturing recovery in Euroland. PMI so far signals that production is falling at a slowing pace, but it is promptly heading towards 50 which signal expansion. We expect that the final May PMI data will show an upward revision as is often the case when PMI rises and this will already then bring us slightly closer to the magic 50. The very sharp increase in the manufacturing new order-inventory balance to a record high level, signals a quick rebound in PMI in the coming months. We thus believe that manufacturing PMI will go above 50 as soon as August.

The steep improvement in PMI is in line with our expectations that GDP growth will become significantly less negative in Q2 than it was in Q1 and Q4 last year. The production levels appear to have become too subdued relative to demand and with very low stocks and an easing in the pace of decline in new orders we project positive growth in Q3. Nevertheless due to the very negative GDP data for Q1 we now think that Euroland GDP will decline around 3.6% this year.

Bottoms in PMI tend to coincide with bottoms in bond yields and hence today's data points to higher bond yields over the next three to six months in Euroland.

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

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