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Friday, April 4, 2008

Eurozone Services and Economic Sentiment Slip Back

by Edward Hugh: Barcelona

European services growth slowed in March as the euro rose to a record and the U.S. economic downturn continued its course. The Royal Bank of Scotland index of growth in service industries (ranging from banks to airlines) fell to 51.6 from 52.3 in February. That's just a touch lower than the initial estimate of 51.7 published March 20. The index is based on a survey of purchasing managers and a reading above 50 indicates expansion. But more than the overall reading, what matters here are the individual country differences, as some countries continue to resist the downturn while others plunge headlong into it.

France remained the only one of the Eurozone’s "big four" economies to see growth holding up close to that seen in 2007. Business activity in the German service sector also continued to expand, but the rate of growth was well down on levels achieved last year, registering the third weakest monthly growth rate for the past three years. Spain and Italy, on the other hand, both reported falling levels of business activity for the third and fourth consecutive month respectively. The rate of decline in Italy itsthe third steepest in the past three years. There was a marked acceleration in the rate of decline in Spain, with services contracting far more rapidly than they are currently doing in Italy, and indeed the contraction rate registered in Spain was the fastest in the services survey’s eight-and-ahalf year history.


The rate of new business growth slowed among French service companies in March although the services sector as a whole continued to expand at a fairly robust pace. The NTC/CDAF Research's Purchasing Managers' Index (PMI), fell to 57.3 in March from 58.2 in February, but kept above the 50 mark separating growth from contraction for a 57th month running.

The new business index fell to 56.6 in March from 57.2 in February, showing demand in the euro zone's second largest economy is easing but still remains solid.

"This report seems to suggest that there's still some robust spending occurring, certainly on services," said NTC's chief economist Chris Williamson.

While French consumer confidence hovers at its lowest level in over 20 years, the National Statistics Office (INSEE) expects French households to remain resilient and buoy the economy this year by dipping into their savings. While surveys consistently show the French are worried about high inflation eroding their purchasing power, these concerns evidently did not feed into actual spending in February, which rebounded again according to the latest data from INSEE.

Inflation also made its presence felt in the March PMI, as the input price sub-index rose to its highest since November, and the 'prices charged' index rose to its highest level since January. But NTC's Williamson said that France's rising prices had yet to have negative effects on other elements in the service sector such as employment, which rose on the month.

"If non-staff costs are rising, they may look at trimming wage costs. But that doesn't seem to be happening here because the employment index is still remaining at this robust level," he said


In Germany, Europe's largest economy, services growth slowed, with the index dropping to 51.8 from 52.2 in February. Still German services continue to expand, and this gives us yet another measure of the extent to which the German economy - for the time being - continues to resist.

As for the details, new business grew more slowly, as did net hiring. Tim Moore, an economist at NTC, said that on average, figures for the first quarter pointed to the weakest growth in the German service sector in four and a half years.

"With activity growth slowing, and backlogs of work falling for a fourth month running, job creation came under pressure in March and was the weakest since October 2006," he said.

Business expectations among German service firms dipped to their lowest level in four months, registering a level of 50.3, as the mood among financial intermediaries hit a record low.

"There were divergent trends across the service economy, with new work rising at a solid pace at firms operating in renting and business activities, but contracting markedly in the financial intermediation sector," NTC said.

The most optimistic companies were those operating in the hospitality, transport and storage sectors.


Italy's service sector continued to contract for a fourth consecutive month in March, though the rate of contraction was less than February's record rate, as employment fell and input prices rose at their fastest pace on record, according to the latest NTC/ADACI survey publised today. The NTC Research Purchasing Managers Index rose to 48.8 from February's 47.2. Despite the recovery from February's all-time low, March's reading remained below the 50 divide between growth and contraction for the fourth consecutive month.

Despite the fact that we still do not have the GDP growth reading for Q4 2007 from the Italian statistics off it is hard not to draw the conclusion that Italy is now in recession.

"These figures, coupled with the manufacturing PMI, suggest Italy's economy has started to contract," said Chris Williamson, chief economist at NTC Research which compiles the data. "It's hard to see any silver lining and it doesn't seem the worst is over by any means," he said, forecasting Italian gross domestic product fell 0.1 percent in the first quarter.

The March PMI for Italian manufacturing fell to 49.4, again below the 50 threshold, the first time Italian industry has shown such a reading since June 2005; business confidence as measured by the ISAE institute also hit a 31-month low in March; and consumer confidence was the lowest since May 2004. In addition the seasonally adjusted PMI for retail sales collapsed to the staggeringly low level of36.4 in March from the already very weak level of 43.8 registered in February.

The PMI services survey also showed that the sub-indexes for new and outstanding business both rose but remained below the 50 line while the employment and confidence components dropped.

"Business expectations remain the second weakest since September 11, 2001 and they are getting entrenched at this level," said Williamson. "They have never been so low for so long."


Business conditions for Spain's services companies deteriorated in March at the fastest pace ever recorded during the nine years for which this survey has existed in March. The Spanish headline Purchasing Managers Index turned in a reading of 40.9 - well below the 50 cutoff point between growth and contraction. This was also the lowest level ever for any of PMI dervices survey for a European economy.

This latest reading gives us an indication of just how rapidly the global credit crisis is now undermining Spain's long-running economic expansion, an expansion which had drawn most of its force from household borrowing against rapidly rising housing prices.

"In Spain it seems to be an all-round malaise," said Chris Williamson, NTC's chief economist. "It was a dreadful survey."

This result follows the manufacturing survey on Tuesday which showed Spain's manufacturing sector put on its worst performance in over six years in March as output shrank sharply and firms reduced staffing.

The Spanish services PMI, which fell nearly 6 points to 44.2 in January, had recovered a little in February to 46.1.
"While still indicative of optimism, the Business Expectations Index eased to 57.1, from 59.2, and was well below the survey average of 72.1," said NTC. "Negative expectations were attributed to fears for the wider Spanish economy."

New orders fell in March at their sharpest rate in the history of the services survey and companies' costs continued to rise sharply, although the rate of input price inflation eased from February's 87-month high.

Spain on Monday reported a 4.6 percent inflation rate in March, fuelled by global food and fuel prices and raising the prospect of continuing strong inflation during a year of sharp economic slowdown. In other words, in the very best case the Spanish economy is now suffering from some form or other of stagflation. But if the deceleration continues at the present case worse may be to come, since stagflation in the context of a rapid fall in house prices and growing insolvency (both corporate and private) can rapidly - as we have seen in the Japanese case - convert itself into some form or other of endemic price deflation.

EU Economic Sentiment Indicator

The European Commission has also now reported its eurozone “economic sentiment” indicator for March, with the composite number bouncing back a little from the February reading which its lowest level since December 2005. The indicator, which gauges optimism across all economic sectors and is regarded as a good guide to likely future trends, was back up to 102 after falling to 100.1 in February from 101.7 in January. As we can see in some of the counries shown in the chart below, the picture is a mixed one, with Germany for the time being holding reasonably stable, climbing back to 104 from 103.7 in February, Ireland hovering nervously, Italy continuing its steady downward path, and Spain continuing to head steadily off the map. The March reading in Spain was 83.9 which was down from 87.5 in February. I suppose here it is a case of how low can you go before you hit bottom. Yet awhile I suspect.

France meanwhile continues to hold up fairly well, rising to a composite 105.6, from 105.2 in February.