Economy in Brief: 2022

The European Monetary Union (EMU) posted a 0.7% increase for industrial output in June, following a 2.1% increase in May. Industrial output is solid with a 2.6% growth rate over 12 months, 2.3% growth rate over six months and a 13.8% annualized rate of growth over three months. The tracking for manufacturing growth alone generally follows the same pattern with a 1% gain in June and 11.9% annualized rate over three months.

The June report completes data for the second quarter. In the second quarter, total output is up at a 4.5% annual rate; manufacturing output is up at a 2.3% annual rate. Output gains by sector are led by consumer durables at a 9.4% annualized rate. Consumer nondurables output rises at a 4.9% pace, capital goods output has come back strongly with a 5.6% annual rate increase, and intermediate goods output showed a decline at a 1.4% annualized rate.

All the sectors show increases in output compared to the pre COVID level of output in January 2020. Overall output is up 2.7% with manufacturing output up by 2.5% over that span. Consumer durables has the largest gain at 6.3% followed by consumer nondurables at 5.6%. The smallest gain is from the capital goods sector with a rise of 0.9%. Intermediate goods output is up by 2.2% over the span.

The manufacturing and industrial output performance numbers do not fit well with the manufacturing PMI as the manufacturing PMI show reduced activity in April, May, and June. In all three months manufacturing output progressed from the flat in April to up 1.8% in May and up 1.0% month-to-month in June. However, at a PMI diffusion value of 52, the manufacturing PMI gauge for the EMU does show expansion. But it doesn't show strength; it is showing persistent cooling.

The survey of housing market conditions in the U.K. continues to show strength in prices versus weakness in activity. Housing price expectations, however, were reduced on the month as new sales continued to post weaker results and sales prospects fell sharpy to a weak level. The residential survey from the Royal Institute of Chartered Surveyors (RICS) demonstrates the growing malaise and also the mixed set of conditions in the U.K. housing market.

To be sure, house prices continue to gain. But the pace of those gains is slowing as the diffusion index is down to 63 in July from 65 in June and 71 in May. Still, these surveyed values, which are net diffusion indexes, show that on balance there are more prices increasing than decreasing since the reading for July is over 50. Viewed as a percentile standing on data back to 1999, the current three-month trend for the price diffusion index has been higher only about 8% of the time. On this observation alone we might think some weakening is in order.

The clear take away from this survey about prices is that they're still moving up and the upward momentum is still significant. However, a second and perhaps more important take away from this is that the breath of the improvement in the index is shrinking. Recently in this cycle - as recent as April of this year, and February - the house price diffusion index had values as high as 78. Back in June and July of a year ago, the house price index had values of 80 in July and 83 in June.

These conditions have changed as house price expectations have withered; expectations for three-months ahead fell to a net reading of +1 in July from +2 in June and from +12 in May; over the last three months this metric averaged +5; over six months it averaged +16. Clearly house price expectations are diminishing and although the net readings are still positive that is an outlook for prices to rise that is now down to its thinnest possible margin of one-point. Viewing this reading of price expectations against historic data, price expectations have been stronger than this nearly 58% of the time. The metric for price expectations is now below its historic median. And remember this is a thinning and a narrow margin for expected price increases in an economy with severe rising inflation in other prices.

At the same time, new sales log the value of -13 in July which is a very slight improvement from the -14 reading in June. New sales had slipped to that level from -5 in May. The six-month average for new sales has been -4 while the 12-month average is -7. Actual sales have been logging net negative values for some time, but clearly the weakness has just ramped up and gotten more severe.

Expectations for three months ahead echo these changes but with a bit more emphasis. Sales expectations in July slipped to -20 from -11 in June and to minus-one in May. Their six-month average is at zero while their 12-month averages is at +7. Sales expectations have averaged positive numbers for 12 months and flat numbers over six months; this series this has transitioned into a relatively steep negative outlook with the July reading of -20. The July reading, in fact, has a standing in the lower 3.2 percentile of its historic queue of readings on sales expectations. Sales expectations are weaker than this only about 3% of the time. And this is not surprising because actual sales have slipped to a ranking below the 25th percentile so that they are weaker than their current level only about one-quarter of the time. Current and expected-future sales erosions are in sync

The German inflation rate as measured by the HICP accelerated to 8.4% in July from 8.3% in June; this gain is still short of the peak pace of 8.8% in May. The core rate moved up sharply to log a 12-month gain of 4.6% from 4.2% a month ago; it is also short of its peak rise of 4.7%, also in May. Still, these are high rates of inflation and well above the target for all the European Monetary Area, a target of around 2% since the new objective for the ECB is an average of 2%.

The month-to-month change in the July HICP was a gain of 0.6%, a sharp turnaround from June’s 0.2% drop. The core rate also rose by 0.6% in July, also sharply higher than its 0.3% decline in June. Both the headline and the core measures had risen sharply in May with the headline up 1.1% month-to-month and the core up 0.8% month-to-month. What we learn by looking at the monthly values is not much. May saw a terrific spike, June gave us some relief from that spike, but now in July inflation is back running hot – even as energy prices cooled a bit.

The German domestic measure of inflation has tracked the same changes as the overall HICP. The headline rose by 0.5% in July after falling by 0.2% in June and currently shows a 7.6% increase year-over-year. The CPI excluding energy for the domestic inflation measure shows a 0.6% rise in July after falling by 0.3% in June; it is up by 4.4% year-over-year (a bit less than the core for the HICP measure).

Over the 11 categories in the table, inflation is accelerating in 59% of them in July. This is a sharp pickup in diffusion from June and May when inflation was accelerating and only 27% of the categories and 18%, respectively.

However, the sequential diffusion readings are much more worrisome. Over three months inflation diffusion is 63.6%, over six months it’s at 72.7%, and over 12 months it's 54.5%. The diffusion calculations represent the percentage of the categories with inflation rising and half of the categories with inflation unchanged; a value of 50% is neutral in terms of inflation acceleration and deceleration. Values higher than 50% indicate inflation is accelerating; values below 50% indicate a deceleration. Of course, the actual inflation figure for the month may not behave this way because the inflation statistics are weighted. The diffusion statistics are not weighted; they're just applied across categories.

Even though headline inflation is up sharply over 12 months at 8.4% compared to 3.2% a year ago, the diffusion calculation on that comparison is only at 54.5%, just a small measure above the 50% acceleration guideline. Setting aside the issue of the weighting the categories, one of the reasons that the diffusion indexes is low while inflation itself accelerates sharply over 12 months is that among the categories that see price increases the acceleration averages about five percentage points whereas among the categories where inflation decreases, the decelerations average only about two percentage points. But the diffusion calculation is about the number of categories that are moving not about magnitudes. So, with six categories accelerating and five decelerating, the accelerators win and we get a diffusion reading slightly above 50%. But in terms of the inflation number, we get a much higher inflation number than this diffusion calculation would suggest because where inflation is accelerating it's accelerating sharply and where inflation is decelerating it's decelerating at about half the pace of its acceleration. This, of course, is in addition to the differences in weighting across the categories. Diffusion is a useful metric we see it used in the PMI reports, for example. But it also has some limitations. One thing it is good for is assessing inflation’s breadth. As of July, over six months and three months, inflation is rising both strongly and broadly.

Oil prices were factor tending to move inflation lower in July. Brent oil prices expressed in euros had risen by 7.6% month-to-month in May and by 5.3% month-to-month in June, but in July those prices fell by 7.3%. Sequentially, Brent prices have slowed down as well. Brent rises at a 21.6% annual rate over three months, at an 85.9% annual rate over six months and at a 64.1% annual rate over 12 months. This compares to a rise of 66.9% year-over-year one year ago. The break in Brent prices should help to pave the way for milder inflation in the future if global oil prices continue to trade in this lower range or lower.

The bottom line for Germany is that inflation is still far too strong. The ECB is raising rates, but it is also worried about fragmentation in the euro area and the threat of an energy cut off from the Russian pipeline that would cripple most of Europe. Russia has reduced the oil flow already using what many regard as a bogus maintenance excuse. Inflation is clearly too high in the EMU; it continues to cook at a torrid pace in Germany and in Europe and yet the ECB finds its hand is stayed by concerns about how geopolitical and economic risks interact in the euro area. It's a tricky situation all around and inflation is still far too high.