Tuesday, May 3, 2011

Manufacturing still the star sector

Manufacturing indices in Europe and the US remained at high levels in April, indicating the sector continues to provide much of the growth momentum in these economies. By comparison, the China manufacturing index weakened slightly in April, consistent with a modest slowdown in economic growth.

The US ISM manufacturing index fell slightly from 61.9 in March to 60.4 in April. A reading over 50 tells us manufacturing is expanding. Despite the softening, this is the fourth consecutive month in which the index has recorded a level over 60. In more normal times, this would be consistent with GDP growth of around 4.5%, but these are not normal times. In other sectors low or negative growth, most notably consumption and residential construction are constraining the overall recovery.

The key sub-indices of production, new orders and employment all declined by varying degrees, but all remain at high levels. The prices paid index remains elevated at 85.5 (up from 85 in March), reflecting high commodity prices. The survey doesn’t tell us anything about the extent to which higher prices are being passed on to end-consumers but it seems reasonable to assume that soft final demand is making this difficult. That’s good for inflation but bad for profitability.

There was a sharp rise in the inventoroies index after two months of decline. I wonder whether there is some stock-piling of raw materials in the face of rapid increases in commodity prices.

In Europe, the Markit Economics 17-country manufacturing index rose from 57.5 to 58. Germany and France are leading the charge. For Germany strong demand from China (largely for motor vehicles) is one of the key factors behind the strong growth. This of course makes the sector vulnerable to any slowdown in demand from China.

Manufacturing remained weak in the European periphery, again indicating the high degree of divergence in economic performance across Europe. This in turn highlights the risky approach taken by the ECB to raise interest rates recently, but supports the line that this won’t be an aggressive tightening cycle.

The China Purchasing Managers Index fell to 52.9 in April. This is down on the 53.4 recorded in March and well below the median expectation of 53.9.

This is consistent with a moderation in China GDP growth this year. To-date that slowdown has been less than expected – year to March 2011 GDP growth came in ahead of forecast at 9.7%, down only slightly on the 9.8% for the year to December 2010.

A slowdown in growth in China is a good thing. Monetary conditions have been tightened on a number of fronts since 2010 with numerous increases in the required reserve ratio, four increases in interest rates since October last year and an over 5% appreciation in the Chinese Yuan (CNY) versus the US dollar.

With the economy running at capacity, we still think further monetary tightening will be required. In particular, further appreciation of the CNY will aid the fight against inflation but also assist the reduction in global imbalances.