Economy in Brief

The INSEE survey for France that evaluates manufacturing and services sector firms shows a strong rebound for manufacturing in October and a solid rebound for services in the same month. However, the two sectors are experiencing significantly different environments, with the industry climate reading for manufacturing at a 76.5 percentile standing, putting it in the top 25 percentile of all performances back to 2001. The services climate reading is at a 42.8 percentile standing, leaving it below its historic median over the same period.

Manufacturing The manufacturing survey shows manufacturing production expectations improved slightly, moving from a -9 reading in September to -8.5 in October; the recent trend for production increased to 2.3 in October from -1.4 in September. While participants in the survey found the prospects for their own industry, the personal likely trend rose to 18.6 from 14.3 in September. The assessment of the industry trend is still a weak one with a 40th percentile standing; however, the personal likely trend is quite strong at a 93.8 percentile standing. This shows that participants have a much more upbeat view of their own industry compared to their expectations for the manufacturing sector as a whole. Since the survey is a broad one across sectors, these results make the survey somewhat inconsistent with itself.

Orders and demand improved sharply in October with the net rating of -10.5, sharply improved from -15.8 in September. The response for foreign orders and demand showed an even stronger positive shift to -1 from -10.1 in September. The rankings for orders and demand show a 74.2 percentile standing for the overall reading, while foreign orders & demand have an 87.3 percentile standing; both of these are quite strong.

The outlook for prices diverges, with firms seeing their own likely price and trend for their industry at 10.6 in October, lower than 14.6 in September. However, for the manufacturing sector price level, they look for an escalation to 31.1 in October from 24.7 in September. The own likely price trend has a 78.1 percentile standing, while the manufacturing price level has an 83.3 percentile standing; both are looking for significant upward pressure on prices.

Services The services survey in October shows an increase in the climate indicator to 99.3 from 97.8 in September; however, it still leaves the sector with a 42.8 percentile standing, below its historic median. The three-month average and the 12-month average of the climate gauge both show improvements; in both cases, they're relatively small, but a lot of that is the result of the smoothing. In terms of the rankings, the rankings for the three-month and 12-month measures are fairly similar to the ranking for the reading for the current month in October.

The outlook improved to -9 in October from -10 in September but still has only a 34.6 percentile standing, nearly a lower 1/3 standing for the outlook.

For sales, the observed performance over the last three months weakened to -5 in October from -1 in September. However, the expectations for three months ahead improved to 3.9 from 0.6 in September. The past observed trend is weak with a 22.5 percentile standing, while the expected result for the three months ahead has an above median, at a 60.8 percentile standing. With such a weak outlook, the turnaround on sales is surprising.

On the price side, there are slightly mixed results, with the observed trend over three months falling to 2.2 in October from 3.4 in September against the expected trend over the next three months, which moved up to 5 from 4.6 in September. The ranking of the past three-month trend is a 77.8 percentile standing; the ranking for the expected trend is a stronger 89.2 percentile standing.

Inflation in the United Kingdom is back to misbehaving in September. The HICP rendition of inflation posted a 0.5% increase, its second in a row, following a 0.6% increase in July. The CPIH, however, performed exactly the same, with a 0.5% increase in September and August, after a 0.6% gain in July. This is going to put the Bank of England's back up against the wall when it comes to making its next interest rate decision.

Hot, hot, hot: Inflation runs hot in the United Kingdom. The CPIH version shows a 6.6% annual rate over three months, a 4.2% pace over six months, and 3.6% over 12 months. This is a clear accelerating profile with inflation clearly over the 2% mark over each one of those horizons. A year ago, inflation was rising 4.1% year-over-year. There's very little here to provide any escape from the conclusion that interest rates need to go up and inflation is a problem that needs some strict attention.

Core inflation is rising as well: Core inflation in the U.K. under the CPIH measure rose 0.4% in September after rising 0.2% in August and 0.4% in July. The sequence of core inflation rates from 12 months inward shows a 12-month pace of 3.1%, a six-month pace of 3.2%, and a three-month pace of 4.1%. These increases are faster-paced step by step as horizons shorten. However, like the headline, all three of these metrics are above 2% and once again there is this accelerating trend in place, even for the core, and that has to be an even more difficult pill for the Bank of England to swallow.

Inflation acceleration: If we look at the tendency to accelerate, acceleration occurred in 58.3% of the categories in July; that proportion fell to 41.7% in August, and it was back up to 50% in September. So, as of September, the proportion of these categories showing acceleration is split pretty much 50/50, making it less of a clear acceleration imperative on volatile monthly data. However, over three months compared to six months, 75% of the categories are accelerating; over six months compared to 12 months, again 75% of the categories are accelerating; over 12 months compared to 12 months ago, that proportion drops to 41.7%. But the drop in the breadth of inflation is also related to the fact that the 12-month inflation rate had dropped from a year ago at 3.8% to 3.5%; it dropped more, from 4% to 3.1%, in the case of the core CPIH. In other words, inflation has fallen from a very excessive pace to a still excessive pace, and that drop is ‘endorsed’ by a drop in breadth. Breadth can reinforce direction. And now inflation and breadth both are rising – a bad sign.

Inflation ranking: We also can look at how inflation ranks compared to where it's been and on this basis that we wind up with another troubling finding. The HICP version of inflation has an 82nd percentile standing; the CPIH version also has an 82nd percentile standing and the CPIH core measure has a slightly higher 82.7 percentile standing. So, inflation is high even by historic experience; that compares current year-over-year inflation in September to inflation rates back to the year 2000. On that timeline, in fact, the median for inflation has a 77th percentile standing and the average pace for inflation has a 72nd percentile standing across categories. Now both of these are slightly lower than the actual CPIH version at a ranking of 82%. What that tells us is that inflation has been even more virulent in those categories that have a higher weight in the CPI.

Summing up On balance, this is a poor report; it will probably put the Bank of England's back up against the wall to enforce another rate hike. It's hard to see how the central bank can look at these various measures of inflation and their path and decide to pass on a rate hike at its next meeting, so brace yourself.

The current situation assessment is mixed To the ZEW experts, economic assessments of the current situation in October are split, with slight deterioration reported for the euro area as a whole and a two-point step-back for China. However, for Germany and the United States, there were significant improvements with the month-to-month diffusion indexes improving by 6 points in the U.S. and by 11 points in Germany. Ironically, both of the weakening areas, the euro area and China, have percentile standings above their historic medians, with China at a 76.1 percentile standing and the euro area at a 58.7 percentile standing. Germany and the U.S. show some strengthening month-to-month, but their standings are still below their historic medians. The German standing is at a 42.5 percentile and the U.S. standing is at a 46.2 percentile.

Economic expectations ease broadly Economic expectations, however, are unequivocally weaker across the reporting countries. There were declines in expectations in Germany of 6.6 points, in the U.S. of 5.3 points, and in China of 4.2 points; each of these three reporters shows a measurable slippage in October. Among the three countries showing slippage, only Germany continues to report economic expectations ranking above its historic median, at a standing of its 53rd percentile (a ranking above 50 means above median).

Inflation makes a sharp step back The real story of the ZEW survey this month, however, is on inflation where the inflation expectations dropped sharply across the board. For the euro area, expectations dropped 26 diffusion points; in Germany, they dropped 24 diffusion points; in the U.S., they dropped 22 diffusion points; and in China, they dropped by 15 diffusion points. Inflation expectations are above their median now only in China, with a 62nd percentile standing. In the U.S., inflation expectations have dropped to a 28th percentile standing.

Rising short-term rates continue as inflation is expected to abate With the decline in inflation expectations, however, short-term interest rate expectations rose by 2 points in the euro area and by 5.2 points in the United States, while in China there was a step-back of 4.1 diffusion points. All three areas, however, have short-term rate expectations well above the historic median levels.

Low inflation expectations boost bond values The reduction in inflation expectations has had the biggest impact on long-term interest rate expectations. Those have fallen in Germany by 13.2 diffusion points; they've fallen in the U.S. by 18.3 diffusion points; and they've fallen in China by 5.0 diffusion points. The ZEW experts apparently think that central banks are going to continue to raise interest rates and the impact is going to be to flatten yield curves globally.

ZEW experts’ outlook for stocks The final market expectation of the ZEW experts is that stock markets generally are seen improving in this environment. For the euro area, there's a 4.1-point improvement; for Germany, a 5.8-point improvement; and for China, the diffusion index is 4.9 points higher. Only the U.S. has a slightly weaker outlook as the outlook falls by 2.3 diffusion points. All the stock market expectations are above their historic medians, generally ranging between readings above 50, at the 54th percentile to the 57th percentile, except for China, where the stock market expectation is in its 83rd percentile, extremely strong.