Euro Area – A Business Cycle Reversal ? Probably

The trend is changing in the Euro Area. After a long period of uncertainty and recession, we see a reversal in the manufacturing sector.
1 – Looking at the PMI/Markit surveys there is now a common dynamic. All the synthetic indices now follow the same trend. In a recent past those indices’ profile was very different one from each other. This is no longer the case as it can be seen on chart 1.
Southern countries as Spain and Italy present a robust profile well above the threshold of 50. France is a little below the common trend. One probable reason can be seen on Chart 3 where France New Export Orders index is decreasing when all the others are up. May be a question of competitiveness?
2 – A lot of adjustments have been done on inventories and flows of orders are up now. The New Orders to Inventories ratio is trending up, well above 1. The ratio of 1.12 has been reevaluated since the flash estimate ten days ago showing a strong momentum.
This ratio’s profile is consistent with the three-month change in industrial production. That’s what shows the second chart.
Industrial production will increase significantly in the coming months. What is important with the manufacturing sector is that it is tradable goods.
3 – New Export Orders indices are trending on the upside (see Chart 3). Euro Area countries which trade a lot one with each other have a new impulse with these orders. In other words, trade between Euro Area countries is increasing and this increases in on manufactured goods. Increasing trade will lead to higher momentum in production.

Euro Area countries have had very close business cycle in the past. The change, the reversal of the cycle, is usually when, after strong adjustments on inventories and on costs, trade restarts. This is probably the case in the Euro Area.

What has changed that can explain this new trend? 
All the adjustments mentioned above and the huge reduction of uncertainty. There was a risk on the Euro Area 6 to 12 months ago leading to a wait and see behavior. This is no longer the case. The probability of a break of the Euro Area went down with a lot of new institutions and new behavior (ECB) seen during the last 12 months.

This is the start of the process as there are a lot of productivity gains in the manufacturing sector. There will be a spillover of these gains to the service sector that generates less of them.
The process will take time but the start seems to take the right direction to improve investment and employment in a foreseeable future.

Chart 1 – Euro Area – Synthetic indices of PMI/Markit Surveys for the manufacturing sector
 EA-2013-august-pmiChart 2 – Euro Area – New Orders to Inventories Ratio and Industrial Production

ea-2013-august-pmi-ratio-ipiChart 3 – Euro Area – New Export Orders Indices


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