Euro PMI Plunge: Another Wake-Up Call For The ECB

There is only one way we can put at least some positive spin on the unprecedented collapse in sentiment among Eurozone purchasing managers: the data are so bad that, perhaps, the European Central Bank may take notice just in time ahead of tomorrow's rate decision. Following these data, it would be even more difficult for Trichet tomorrow to explain a "business as usual" decision to ease only by 50bp instead of the bolder move that is sorely needed.

Of course, ECB council member Bini Smaghi had a point when he said that a central bank must take care not to run out of ammunition. But at 3.25% now, the ECB is nowhere close to running out of rate cut ammunition. And letting the cavalry go under by refusing to shoot when the bad guys are closing in would not be a happy ending to a Spaghetti Western either.

The services PMI index for the Eurozone fell from 45.8 in October to 42.5 in November, even below the initial 43.2 flash estimate. This is by far the lowest level in the 10-year history of the series. The details reveal a major drop in new business from 43.2 to 40.4 and a more modest decline in hiring intentions, from 48.4 to 47.9. In line with falling oil prices and weakening demand, inflationary pressures are declining, taking the readings from input prices down from 57.5 in October to 54.3 in November and for output prices from 50.4 to 47.1, the lowest level since July 2003.

The bad news from the more inward oriented service sector follows the downward revision to the more export-oriented manufacturing PMI for November on Monday, from 36.2 to 35.6, far below the 41.1 recorded in October. This takes the composite PMI down to a dismal 38.9 for November after a bad 43.6 in October. It goes almost without saying that the November result is the worst in the 10-year history of the composite indicator as well.

Unfortunately, the purchasing managers index is the best leading indicator for the immediate future of the economy. The current reading of the composite PMI is compatible with a  2.7% yoy decline in Eurozone GDP in 1Q 2009 (see picture below). This is even well below our fairly negative GDP forecast. We expect the annual rate of GDP change to trough at -1.9% in 2Q 2009. Once again, the leading indicators project that the risk to our - below consensus - calls for growth is still very much to the downside.

Although most ECB speeches ahead of the start of the pre-decision "purdah" period of silence last Thursday still suggested that most council members would prefer to cut rates by 50bp, we maintain our view that - faced with the bad data - there is a 65% chance that the ECB will deliver a 75bp cut tomorrow. A steep cut is necessary, in our view.

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Source: Reuters, Eurostat



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