The eurozone economies, especially the export-led German economy, proved particularly vulnerable to the collapse in global demand after the failure of Lehman Brothers investment bank. Hopes of a recovery are based on signs that companies have run down inventories and will need to step up production to meet orders. And this, it is true, will give a short-term uplift to output (which is what we are seeing), but for this to translate into renewed expansion, the demand for inventory renewal has to provoke an increase in investment to fuel what is perceived as a future increase in demand, and it is far from clear that we are seeing this at this stage.
We do not have detailed data for Q1 GDP for the eurozone economies yet, but if we look at the evidence from Japan, investment activity slumped massively in the first three months, and there is no reason why the situation should be very different in Europe. Business investment was down a record 10.4 percent year on year in the first three months, and a massive 35.5% over the last quarter.
However, eurozone economic activity will continue to come under pressure in the months to come as the impact of the sharp contraction in activity feeds through into the labour market. And companies are likely to keep cutting spending because the decline in external demand has left factories operating well below capacity level, and semi-idle workforces can only be retained for so long. Markit said that the pace of job losses had eased this month – but only slightly compared with the record pace reported in April.
May’s eurozone “composite” index, covering manufacturing and services, stood at 43.9 in May, up from 41.1 in April, the highest since September.
The flash reading only gives details for two of the euro area's big four. The rate of decline in Germany's private sector eased to its slowest in seven months in May, and the composite index rose to 44.4 from 40.1 in April, suggesting the contraction in the second quarter will be much slower than the 3.8% slump (15.2% annualised) in the first. Markit estimated that we may be looking at something like a 0.6 decline (-2.4% annualised). The outcome may be a bit worse than this, but still a significant improvement seem certain.
The German manufacturing PMI index rose to 39.1 from 35.4 in April, while the services sector index rose to 46.0 from 43.8. The manufacturing index was dragged down by major job losses in the sector, and according to Markit "Manufacturing employment in Germany is falling at a far, far faster rate still than services...Manufacturing has really been hammered even though there was some easing in the rate of job losses in May."
The French services PMI was up at 47.6 in May from 46.5 in April, while the manufacturing sector also rose to an above expected level of 43.1 from 40.1.
At the same time it would be very premature to draw the conclusion that we are out of the woods yet. The euro hit 1:40 to the dollar on Friday, and with this level it is hard to see how German exports are going to stage a recovery with currencies like the Swedish Krona and the UK pound down something like 20% over the last year, and German companies now having to look beyond the eurzone to find customers.