Precautionary spending blunts PMI signals
Composite activity readings slumped more than expected across the eurozone, albeit surprised to the upside in the UK. That said, even positive headlines come with a sting in the tail this month. Precautionary spending, as firms stock up in anticipation of future supply chain disruption, is temporari
We find little reason for comfort in the April flash PMIs after full consideration of the reports.
Composite activity readings slumped more than expected across the eurozone, albeit surprised to the upside in the UK. That said, even positive headlines come with a sting in the tail this month. Precautionary spending, as firms stock up in anticipation of future supply chain disruption, is temporarily propping up demand – a dynamic that is not long-term sustainable. Still, this poses a challenge for policymakers, who now need to balance an immediate rise in inflation against a troubling drop-off in future growth prospects. That, we think, warrants a wait-and-see approach, rather than knee-jerk policy tightening.
Precautionary spending is boosting demand temporarily, especially in manufacturing, but PMI details hint at a slump in the coming months, belying positive headline figures
Looking at the April reports, headline PMIs point to a growing divergence between the eurozone and the UK.
The former saw a notable hit to services activity, but an upswing in manufacturing, a pattern repeated across both France and Germany. For the bloc as a whole, the composite sank from 50.7 to 48.6, below expectations of 50.1, ending a 15-month string of expansionary readings.
And even the upswing in manufacturing is not the bright spot it first appears.
Anecdotally, firms indicated that this is being prompted by inventory build-ups in response to rising energy costs and in anticipation of supply chain disruption. Indeed, new orders overall decreased at the fastest pace for almost a year and a half, while April sentiment was the lowest recorded since November 2022.
For the UK, in contrast, flash PMIs suggested that the growth picture might not be as bad as we have feared in recent months. The composite activity index rose to 52.0, up from 50.3 in March. The services PMI also printed at 52.0, while for manufacturing, it rose to 53.8. Both exceeded expectations by some distance, with pre-release expectations predicting 50.0 and 50.3, respectively. Similar to the eurozone, however, firms reported “that customers had brought forward orders and sought to build safety stocks in the expectation of rising prices and supply constraints”.
That leaves us sceptical about the durability of this month’s improvement in headline readings.
What seems clear across both the eurozone and the UK, though, is that where demand remains solid, this is now translating into rising output costs. Firms are widely reporting rising input prices, largely stemming from Middle East related disruptions. But an associated rise in manufacturing prices charged across the eurozone, and for both manufacturing and services charges in the UK, points to a broadening in price pressures that is likely to make central bankers wary.
Yet despite this, we still think a wait-and-see approach is likely best, albeit with different rationales for the ECB and the BoE.
As we see it, the ECB should take some comfort from the lack of pass-through to services, where the prices charged index remains little changed. That limits upside inflation risks, even as longer-term growth concerns continue to build. Absent a sustained rise in service costs, we see scope to look through rising goods prices, allowing the ECB to leave rates untouched for the time being. Admittedly, the BoE faces a more difficult balancing act, with the PMIs pointing to a broad rise in price pressures. However, this also needs to be weighed against a labour market that appears increasingly soft. A further unwind in employment conditions should help to contain inflationary pressures at manageable levels, provided the current rise in energy costs proves temporary, especially with Bank Rate still set at a level that we think is above the longer-run neutral range. As with the ECB, then, we think a wait-and-see approach is most likely from the MPC.
In both cases, that would imply a more dovish path for rates than expected by markets.
If we are right, then this should translate into downside for both the euro and the pound against the dollar, with weakness more pronounced in the case of sterling. Granted, such a readjustment will likely play out slowly, meaning a drag on the valuations of both in the coming weeks, rather than an immediate break lower. We will be looking closely at the policy meetings later in the month for confirmation or pushback on this thesis. But for the time being, we remain comfortable with our central call for both currencies to underperform the dollar for as long as US-Iran tensions continue to disrupt energy markets.