Euroland: Very Weak PMI Should Spur ECB to Cut Rates Dramatically

Overview: Yet again, flash PMI for Euroland fell unexpectedly sharply from the previous all time low, and our below-consensus estimate proved too optimistic. This is clearly worrying - the composite PMI is now signalling close to -0.4% growth q/q (-1.6% annualised). It is clear that Euroland is facing a recession that will last well into 2009.

Details: Composite Flash PMI declined sharply to 39.7 from 43.6 and is now at the lowest point since the index began in July 1998. Manufacturing fell from the already record low 41.1 to 36.2

The forward-looking PMI subcomponents were very weak. Thus more weak economic data are likely to come out of Euroland in the coming months. New manufacturing orders fell dramatically from the already record low 36.2 to 29.7. This is by far the steepest decline rate yet registered by the survey (the 5.4 indexpoint decline in October is the second largest drop ever) and is accompanied by a new record fall in new export orders. Furthermore, the stocks of final goods remained close to the record level with a 51.3 reading, while the backlog of work in the manufacturing sector dropped to 32.8 from the previous all time low of 37.2. Overall, this is bad news for both production and ultimately employment.

Composite employment PMI declined further from 46.9 to 45.7. Historically the PMI employment indicator has given good guidance on actual employment growth. Just three months ago the PMI employment indicator signalled employment growth in the area of 0.75% y/y. Now it signals a small decline. We may soon see these labour market dynamics having a more profound negative effect on consumption via falling employment and the derived effects on household savings. In part this cancels the positive effects on consumption from lower inflation.

Price pressure is easing further on the back of lower prices for commodities. The composite input price PMI index declined to 50.3 from 55.3 and is now at the lowest level since July 2003. Output prices "only" declined to 47.6 from 50.8. However, standardised, the decline in output prices PMI is almost equivalent to the decline in input price PMI.

Composite German and French Flash PMI also released today came out 4.7 and 2.0 index points lower respectively. Thus the 3.9 index point decline for the whole of Euroland indicates a fall in the PMIs from Italy and Spain (to be published later).

At the country level, the manufacturing PMI for Germany fell sharply to 36.7 from 42.9 in October. Details on manufacturing flash PMI showed that new orders declined from a previous a record low reading of 39.2 to 30.9. Furthermore stocks of final goods edged higher from 51.3 to 51.7; a new peak in the current juncture. The deteriorating business climate for German manufacturers implies a marked deterioration of employment in the sector. The manufacturing employment index declined from 47.1 to 44.3. Looking forward, the already-bleak outlook for the very export-dependent German economy (see Germany: Recession looming) has deteriorated even further during the past 1-2 months as the financial crisis has spread to the important export markets in Central and Eastern Europe. Thus, a renewed upswing in the German economy looks even more remote that just a few months ago, and we expect more downbeat indicators to come out of Germany over the coming months.

Outlook: Hitting a record low, the flash PMI clearly indicates that the economy is facing a recession. Furthermore, the forward-looking indicators signal that we may see further weaknesses coming out of Euroland in the coming months.

On the back of the surprisingly weak PMI figures, a substantial worsening of the growth outlook due to the escalation of the financial crisis into Central and Eastern Europe, and a significant easing of price pressure due to lower commodity prices, we think the ECB may - in our view wisely - be tempted to act more swiftly than previously expected. We are now looking for the ECB to cut rates by 75 bp in December and by another 50 bp in January 2009. They will properly cut rates further by 25 bp in both February and March. In total this brings the leading rate down to 1.50% before the end of Q1 2009. Previously we were looking for the ECB to cut rates by 50 bp in December and by another 25 bp in both March and June 2009.

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

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