Economy in Brief

The manufacturing PMI values for June showed more worsening than improving, with 10 of 18 reporters showing conditions unchanged or getting worse on a month-to-month basis. However, taking into account the size of the changes across the various reporters, the median PMI rating for manufacturing in June improved to 51.4, an increase of 0.5 points from the month before. The month-to-month deterioration is relatively broad; however, it's also relatively mixed, and when taking the size of the changes into account, there's actually a monthly improvement.

The chart shows that manufacturing has been undergoing improvements generally since late last year, although in the last few months, there has been a topping, a capping, and in some cases a backtracking from the recent high readings. That action reflects the onset of hostilities between the United States and Iran and the on-again, off-again situation with the Strait of Hormuz being open or closed.

Over three months compared to six months ago, the average readings show deterioration in only 5 of 18 reporters. This clearly reflects what we see in the chart, which is a recent improvement over three months compared to six months. The next comparison of 6-month averages to 12-month averages finds that only four reporters are worse off over six months than they were over 12 months. Those four are Mexico, India, Indonesia, and Vietnam. Over 12 months compared to 12 months ago, conditions are better everywhere except in India.

In addition, we can evaluate the manufacturing performance by ranking the current month's observation in a queue of data back to January 2022, a period of about 4½ years. Viewed over that span, only four countries have readings in June below their period medians. Those are Indonesia, India, Turkey, and Russia. All the rest have readings above the 50th percentile, putting them above their historic medians. Japan has an exceptionally strong reading in June relative to its history, posting a 95.4 percentile standing. Mexico, China, Malaysia, and Taiwan also post strong standings, in their 80th percentile.

The median queue standing for the entire group is a 69.2 percentile standing, which is still quite strong. Other summary measures of sequential diffusion show that the proportion of reporters improving over 12 months is 94.4%, compared to 72.2% over 6 months and 61.1% over 3 months. The breadth of this improvement is shrinking over the near-term horizons; however, the tendency for improvement is unmistakable.

Average readings for certain groups at the bottom of the table show that the United States, the United Kingdom, EMU countries, Canada, and Japan, on an unweighted basis, have steady improvements in place from 12 months to six months to three months, with a one-month reading even stronger. The BRIC countries have readings that are marginally stronger but are staying in a tight low range around 50.8 to 51.5. The Asian average shows an improvement from 12 months to 6 months and then backtracking, with the current 3-month diffusion values just slightly above 51, around 51.5.

The global economy has shown some significant improvement recently in the manufacturing sector, and this has occurred despite the ongoing war in Ukraine and stepped-up hostilities involving Iran, including the on-again, off-again closure of the Strait of Hormuz. Oil prices have spiked and have since come down substantially. However, the outlook for peace remains clouded as both sides continue to talk positively about an agreement and a ceasefire, then turn around and violate near-term conditions they have set. This makes it very difficult to handicap the future.

Some inflation progress, but not enough: The headline HICP in June for the largest monetary union economies have largely broken lower, with the exception of Spain. The German headline HICP fell by 0.1% in June after being flat in May. In France, the price index fell by 0.5% in June after growing by 0.3% in May. In Italy, the June index rose by 0.1% after rising by 0.3% in May. In Spain, June brought a 0.3% increase after a 0.2% increase in May.

Core or ex-energy (Germany): The core inflation readings are available for Germany, Italy, and Spain. In the case of Germany, it's an index excluding energy only. June brought a 0.1% increase for the German index, a 0.1% decline for Italy's core index, and a 0.2% increase for Spain’s core measure. On balance, these are a good collection of results from the standpoint of the ECB that has an inflation target of 2% for the European Monetary Union as a whole, but no guidance for individual countries.

Sequentially: Sequentially, the headline inflation rate shows progress in Germany and France, while excesses are stubborn in Italy and Spain. Over 12 months, all the inflation rates are excessive, but France is only technically excessive and probably acceptable at 2.1% year-over-year. Germany's increase over 12 months is 2.4%, Italy's is 3.1%, and Spain’s is 3.6%. The progression of inflation from 12-months to 6-months to 3-months shows accelerations over six months compared to 12 months for France and Italy, while Germany and Spain show decelerations. However, Spain's six-month inflation rate is still 3.3%. Germany has dropped to 2.2%, France is at 3.3%, and Italy has jumped up to 5.5%. Over three months, the German headline inflation rate is zero and France has fallen to 2%, but in Italy’s headline pace has accelerated to 6.9% and Spain remains at 3.3%. These are all compounded rates of change over three months.

Three-month trends are mixed: None of this is really surprising since oil prices have been surging over the period and are now starting to decline. Over 12 months, the oil price is down by 22.6%; over six months, it’s down by 37% at an annual rate; and over three months, the oil price is flat. Much of this price action is still quite recent. These figures are for Brent crude measured in euros. Over three months, German inflation is flat for the headline HICP, while France’s inflation rate is down to 2%. In Italy, the three-month pace is 6.9%; in Spain it’s at 3.3%. Headline inflation still has a somewhat erratic performance over three months, although it's quite acceptable in Germany and France and quite not acceptable in Italy and Spain.

Core inflation is lower but still too high: Core inflation shows much more moderation because the behavior of energy prices leaves core inflation largely unaffected. If the core is affected, it occurs only after a more substantial knock-on effects from other industries. German ex-energy inflation is at 2.3% over 12 months and then settles down to a 2% annualized pace over six months and three months. Italian core inflation is golden on all three periods, at 1.5% over 12 months, down to 1.4% over six months, and down to 1.2% over three months. Spain's core inflation is excessive, although it is making progress toward a more agreeable rate from a European standpoint. Spain’s core inflation is 2.9% over 12 months, remains at 2.9% over six months, then decelerates to a 2.4% annualized rate over three months.

Headline indexes for the European Monetary Union improved in June to a reading of 95.0 from 93.7 in May. The index had been stronger at 96.4 in March; however, it fell to 93.3 in April, recovered slightly to 93.7 in May, and has now reached 95.0. While still below its March high, the index has made progress in the wake of the outbreak of war-like conditions and the closure of the Strait of Hormuz.

Sector performance The industrial reading for the sector, at -8, has a 36.3 percentile standing, which better than the headline index for the Monetary Union with a 25.4 percentile standing. The EMU-wide sector index, consumer confidence, improved to a net diffusion reading of -17.7 in June from -19 in May, but that still leaves it with a very weak 8.1 percentile standing, the lowest among sector readings. Retailing improved to a net diffusion reading of -10 in June from -11 in May and posted a 38.1 percentile standing. The construction sector deteriorated, falling back to -5 from -4 in May; it has been undergoing steady degradation since at least March, but it still has a 68.4 percentile standing. It is the only sector with a percentile standing above 50, placing it above its historic median. The services sector had a net diffusion reading of +3, identical to its May reading and has a 24-percentile standing.

Sector index ranking The sector readings clearly show that the monetary union is exhibiting a number of sectors with subpar growth; beyond ‘subpar,’ many are quite weak. The exception is—and has been for some time—the construction sector, which continues to perform above average and post an above-median metric. It is, perhaps surprising that we often think of consumer confidence as being relatively forward-looking, but in this schematic, consumer confidence is the weakest of the sectors; in fact, like statistics from the U.S., we find the same prevailing situation with consumer readings exceptionally weak. These weak consumer readings coexist with much stronger retailing readings and stronger industrial readings, although both of those are below their historic medians in Europe. This report is a sort of gut check for what consumer confidence means; it may not be as important as we used to think it was. Although the business cycle at this juncture seems to be concentrated more on the supply side and on recovery in the business community, that effect compounded by the influence of AI is much stronger in the U.S. than in Europe.

Country detail – Large economies The country detail shows 16 of 20 early reporting countries with only one of the top four countries showing a decline month-to-month, and that's France. France recorded a 0.2% decline in June, while Germany posted a 1.9% increase, Italy gained 1.3%, and Spain rose 0.7%. Spain had the lone small decrease in May, while in April all of the large countries showed significant monthly declines in their overall indexes in the wake of the onset of the war with Iran.

Smaller economies in EMU Apart from the Big Four economies, 12 other EMU members report in June; of those, 5 showed month-to-month declines in their country level indexes. This was up from three showing declines in May, although it was a vast improvement from April, when all of the country indexes turned negative and generated substantial month-to-month declines, except for Slovakia and Lithuania.

Big Four economy rankings Among the Big Four economies, the strongest ranking reading in June is Spain at a 52.3 percentile standing, followed by Italy at a 41.6 percentile standing, France at a 22.7 percentile standing, and Germany at an 18.7 percentile standing.

Other economy rankings Among the other 12 countries, the percentile standing readings range from a high of 76.1% for Greece to a low of 9.3% for Austria. Five of 12 of the smaller EMU members have percentile standings of 50% or greater, putting them above their historic medians, while the other 7 have rankings that range from a high of 44.6% in Portugal to a low of 9.3% in Austria.

Summing up Conditions in the monetary union have improved over the last two months after a substantial stumble in the wake of the war in the Middle East with Iran and the closure of the Strait of Hormuz. However, the rebound in the European recovery is in gear; it is slow and measured. Conditions are still weak on balance.

In this week's Letter, we explore the significant pullback in oil prices that followed the US-Iran memorandum of understanding and consider its broader economic implications. The agreement saw a fragile ceasefire ensue and a gradual resumption of shipping flows through the Strait of Hormuz (chart 1). We acknowledge that this major pullback will certainly be welcome to policymakers across the region and beyond. Previously elevated energy prices had added to the fiscal burdens of governments and sharpened the dilemma facing central banks (chart 2). That dilemma pits the need to rein in inflation against the risk of choking off economic growth. That said, while one source of inflationary pressure seems to be ebbing, another looks to be emerging on the horizon. It stems from a potential "Super El Niño" event, which meteorologists have been warning about for some time now. Asia sits at the centre of such risks, as past strong El Niño events have directly and adversely affected crop production (chart 3). The impact is not limited to potential surges in headline inflation via food supply shocks, especially in Asia. It extends directly to growth as well (chart 4), given the nontrivial share of GDP that agriculture still commands in many Asian economies (chart 5). Should price pressures simply rotate from energy to food, government subsidies may follow suit (chart 6). Central bankers, for their part, may find themselves unable to ease off the tightening pedal just yet. Some Asian economies, however, would still manage to offset such a growth shock through other engines. Electronics and semiconductors, buoyed by the current AI upcycle, offer one such cushion for the more fortunate. For others, lacking such offsets, the agricultural hit may simply have to be borne in full.

The US-Iran conflict and oil prices The recent memorandum of understanding between the US and Iran, aimed at working towards a final deal, has already brought visible relief to crude oil markets (chart 1). This relief has held despite the renewed tensions that have followed the agreement, which markets seem to have largely looked past. The easing in prices should go a long way towards unwinding the inflation concerns that elevated oil prices had previously stoked. Much of the pullback reflects anticipation of the substantial supply now expected to return to global markets. Yet some shipping trackers, such as the IMF's, already point to a marked pickup in traffic through the Strait of Hormuz. Even so, those volumes still remain well below the levels seen before the conflict began in the region.